Keeping the Veil Closed – Which State Laws Provide Better Limited Liability Protection
FMJ was recently organizing a Minnesota limited liability for a client to buy an aircraft. During the process, the client spoke to a friend who was a securities lawyer who said “Why don’t you use a Delaware company instead? The liability protection is so much better.” We weren’t sure that was entirely true, however, so we decided to take a look.
There is a common wisdom out there among investment bankers and securities lawyers that Delaware has the strongest limited liability laws. This is, in part, why most hedge funds and security offerings arise through companies organized under Delaware law. And there is good reason to think that Delaware offers good limited liability protections. In order to pierce the corporate veil in Delaware, a party must typically consider whether a company to be disregarded:
- was inadequately capitalized,
- was insolvent,
- generally paid dividends and kept corporate records,
- generally had officers and directors functioned properly,
- involved dominant shareholders that siphoned off company funds, and
- in general, functioned as a facade for the dominant shareholder
In addition, however, under Delaware law, disregard of a corporate entity is only appropriate in exceptional circumstances where “fraud or injustice [is] found in the defendants use of the corporate form.” Marnari S.p.A. v. Keehan, 900 F. Supp. 2d 377 (D. Del. 2012) (applying Delaware law). The element of “fraud” is often pointed to as a defining factor in why Delaware’s corporate veil protections are considered so strong.
As a result, the bar is set very high in Delaware to successfully pierce the corporate veil. But is it better than other states?
In Minnesota, the typical test is quite similar. In Minnesota, the courts will not hold officers or shareholders personally responsible for corporate obligations except in limited circumstances including if (1) whether the entity is an alter ego of the shareholder and piercing the veil is needed to avoid injustice, or (2) when an officer has guaranteed the entity’s obligations, or (3) if the officer or shareholder actually participated in the misdeeds of the company. Ransom v. VFS, Inc., 918 F.Supp. 2d 888 (D. Minnesota 2013) (applying Minnesota law).
Although the factors in most Minnesota cases do not go as far as Delaware in requiring fraud, a review of Minnesota cases show that the courts typically apply a bar that is every bit as high as that set in Delaware. The cases typically require both a disregard of a corporate entity’s separate existence and “whether there is an element of injustice or of fundamental unfairness” that would result from honoring the corporate separateness. Whether or not the standard is actually higher in Delaware, the application in Minnesota is very much the same.
Among other states, the standards can vary widely, but others have similarly high standards. In Texas, for instance, the courts require “actual fraud” or a showing of “sham to perpetuate a fraud”.
One also needs to consider what choice of law applies in a given case, such as where a Delaware LLC is operating in another state. Case law in Texas and in Minnesota would likely require that the local court apply Delaware law in deciding to pierce the corporate veil.
It should also be noted that the standards within a state can vary between types of entities based on the varying statutes that apply. In Minnesota, the corporations and limited liability company statutes essentially apply the same standards for both types of entities. At one time commentators argued that the Texas LLC statute created an “impenetrable shield” because the statue did not address veil piercing. (The courts disagreed, applying Texas common law.)
When it comes to planning what type of entity might be used in an aircraft purchase, there are also other considerations that come in to play. Among them, does it make sense to incorporate or organize an entity in one state for operation in another? Does the veil-piercing standard justify the administration of the entity under two state laws? Does the nexus of an entity in multiple states expose the owner to taxes in two states?
As for whether the veil-piercing standards would suggest a difference between using a Delaware LLC for an aircraft based in Minnesota, we would suggest not. But any decision like this depends on the consideration of all the factors that apply to a client and is worth a deeper dive into the circumstances before making a decision.
If you’re interested in learning more about state laws and limited liability protection regarding aircraft, Kevin Johnson can be reached at email@example.com and Adina Florea can be reached at firstname.lastname@example.org or by calling 952-995-9500.