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LLCs: How Limited is Your Liability?

The New Jersey Legislature adopted the New Jersey Limited Liability Company Act in 1993 (the “1993 Act”)1 and thereby ushered in a new form of business enterprise: the limited liability company (LLC). The 1993 Act enabled business owners to “take advantage of both the limited liability afforded to shareholders and directors of corporations and the pass through tax advantages available to partnerships.”2 Thus, LLC Members reap the dual benefits of limited liability afforded to corporate shareholders and pass through tax advantages available to partnerships. After two decades of experience under the 1993 Act, the Legislature adopted the Revised Uniform Limited Liability Company Act (the “Revised Act”)3 in 2013. The Revised Act has been described as a comprehensive, fully integrated second generation” LLC statute that takes into account the best elements of the 1993 Act and two decades of experience in the field.4

The features of limited liability, operational flexibility, and corporate income tax avoidance has made the LLC the entity form of choice for new businesses. Over the past several years, far more New Jersey LLCs have been formed than New Jersey corporations and partnerships combined5. Small and large business owners alike benefit from the LLC form of business. This article considers whether and under what circumstances an LLC member may become personally liable for debts or other obligations of the LLC.

New Jersey follows the well-established rule that a corporation is a separate entity from its shareholders, and that a primary reason for incorporation is to insulate or protect the shareholders from the liabilities of the corporate enterprise.6 The Revised Act extends this important protection to members of LLCs. Section 30 of the Revised Act makes clear that “the debts, obligations, or other liabilities of a limited liability company, whether arising in contract, tort or otherwise, are solely the debts, obligations, or other liabilities of the company” and “do not become the debts, obligations, or other liabilities of a member or manager solely by reason of the member acting as a member or manager acting as a manager.” 7 Section 30 also provides that the failure of the LLC to “observe any particular formalities relating to the exercise of its powers or management of its activities is not a ground for imposing liability for the debts and obligations” of the LLC on its individual members and managers8.

Section 30 offers two significant protections: it creates a “corporate veil” that insulates individual members against personal liability for obligations of the LLC solely because of their status as members and managers; and it bars using the LLC’s failure to observe any particular corporate formalities as a basis for imposing personal liability upon individual members. LLC members should realize these protections are not absolute, and sometimes they can be held personally liable for the LLC’s obligations.

The 1993 New Jersey Supreme Court Ventron decision established a two-part test to determine if a business entity’s “corporate veil” should be pierced: First, the Plaintiff must prove that the business was a mere instrumentality, or alter ego, of its owner; and the Plaintiff also must show that the owner has abused the business form to perpetrate a fraud, injustice or otherwise circumvent the law. 9 Piercing the corporate veil and imposing personal liability upon the dominant shareholder (of a corporation) or member (of an LLC) is a form of equitable relief employed by the Courts “for remedying the fundamental unfairness that will result from a failure to disregard the corporate form.”1° While there has been scant published case law applying a “veil piercing” analysis to LLCs, several unpublished court decisions offer guidance.

D.R. Horton, Inc. – New Jersey v. Dynastar Developmentu was a breach of contract action seeking damages for construction delays and cost overruns incurred in a 400-acre residential development project. That court rejected D.R. Horton’s effort to pierce the corporate veil and impose liability upon the managing member of the LLC general contractor (GC). The court also modified the Ventron two-part test because the GC was an LLC to place lesser weight on the elements of domination and control, and adherence to corporate formalities, given the language of Section 30 of the Revised Act.

In Brown-Hill Morgan, LLC v. Lelirer12, however, the Court applied the more traditional Ventron analysis, and cited several factors, including gross undercapitalization of the LLC, the owner’s day-to day involvement in the project, and the absence of an adequate remedy at law, to affirm the trial court’s decision to impose an equitable mortgage upon the real property and personal liability upon the dominant individual for a $508,167 judgment entered against the LLC.

Factors that the courts consider in determining whether or not to impose personal liability on an LLC member for a debt or obligation of the LLC include: is the LLC grossly undercapitalized; does the LLC maintain business records and observe corporate formalities; has the member made affirmative statements (or material misrepresentations) to the injured party; have assets of the LLC been co-mingled or transferred to the member; and are there other facts and circumstances that confirm the LLC is a facade or sham, or that require the court to remedy a fundamental unfairness that otherwise will result from a failure to disregard the corporate form.13

In Cayuga Properties, LLC v. Pollard,14 a case involving a $20,930 home improvement contract, the New Jersey appellate court affirmed a judgment entered in favor of the homeowner and against the LLC contractor, but reversed the trial court’s decision dismissing alter ego claims against the LLC’s sole member. The trial court dismissed the claims against the member, concluding there was no proof the member had done anything other than in his capacity as an employee and officer of the LLC. The appellate court disagreed, finding that statements made by the member to the homeowner, including that he was experienced….and would do a high quality job” and that the project would be completed “promptly and quickly,” demonstrated sufficient affirmative conduct by the member to create fact questions for the jury to decide whether or not to hold him liable for the LLC’s obligation. The potential impact of a ruling imposing personal liability upon the LLC member can be substantial, particularly where, as in the Cayuga Properties case, the injured homeowner recovered treble damages and attorneys’ fees for the LLC’s violations of New Jersey’s Consumer Fraud Act.15

A similar result occurred in Luma Enterprises, LLC v. Hunter Homes & Remodeling,  LLC (“Luma”).16 Luma  involved a $485,000 contract to renovate a pre-school and daycare facility. Luma sued the GC and individual members of the LLC after they accepted $388,000 in payments but then stopped work and walked off the job because the payments were late. The trial court dismissed all claims except the breach of contract claim against the GC. The Appellate Court upheld dismissal of claims that the GC had violated the Consumer Fraud Act, but reversed the trial court’s decision dismissing the claims against the individual LLC members: “The reality is that [the GC] had no underlying substance and no capital. Absent piercing of the corporate veil, Luma lacks an adequate remedy at law.”17 In contrast, in Okolita v. 1313K Group,18 the trial court’s dismissal of homeowners’ claims seeking to impose personal liability upon Jerry Russo, for alleged breach of contract and Consumer Fraud Action violations by the LLC GC, was affirmed because the evidence confirmed Russo had no interactions with the homeowners and no role running the LLC.

In sum, New Jersey’s Revised Limited Liability Company Act offers significant protections against individual liability to members and managers of LLCs. Those protections are not unlimited. New Jersey Courts will “pierce the corporate veil” and impose personal liability upon individual members for debts and obligations of the LLC to prevent the LLC from being used to defeat the ends of justice, to perpetrate a fraud, to accomplish a crime, or to otherwise evade the law.

If you have any questions about this post or any other related matters, please contact me at jfgallagher@norris-law.com.

1 N.T.S.A. 42:2B-1, et. seq.
2 New Jersey Senate Commerce Committee Statement, S 890 (June 14, 1993)
3 N.T.S.A. 42:2C-1, et. seq.
4 January 30, 2012 Assembly Regulatory Oversight and Gaming Committee Statement to the Revised Uniform Limited Liability Company Act, N.T.S.A. 42:2C-1, et. seq.
5 Id.
6 State, Dept. of Envtl. Prot. v. Ventron Corp., 94 N.J. 473, 500 (1983) (“Ventron”).
7 N.J.S.A. 42:2C-30.
8 Id.
9 Ventron, supra, 94 N.J. at 501.
10 Verni ex rel. Burnstein v. Stevens, 387 N.1. Super. 160, 199 (App. Div. 2006), certif. denied, 189 N.J.  429 (2007)
11 2005 WL 1039778 (N.J. Super. Ct. Law Div. 2005) (unpublished)
12 2010 WL 3184340 (N.J. Super. Ct. App. Div. 2010) (unpublished)
13 Verni, supra., 387 N.1, Super. at 200.
14 2014 WL 259018 (N.J. Super. App. Div. 2014).
15 N.J.S.A. 56:8-1, et. seq.
16 2013 WL 3284130 (N.J. Super. App. Div. 2013) (unpublished)
17 Id. at 3284137.
18 2014 WL 4997381 (N.J. Super. App. Div. 2014) (unpublished)