A New Corporate Veil Piercing Standard in West Virginia - An Inequitable Barrier

Jiaye Hou

The general rule of today’s U.S. corporate law is that a corporation is considered a legal entity, separate and distinct from its shareholders.[1] Evolving with the principle of limited liability, this separation of legal entity has been adopted primarily to encourage investment and entrepreneurship. The Delaware Limited Liability Company Act, for instance, provides that members and managers of LLCs shall have no liability solely by being a member or acting as a manager.[2] Similarly, SCOTUS has ruled in numerous cases that “a basic tenet of American law is that the corporation and its shareholders are distinct entities,” and “it is a general principle of corporate law deeply ingrained in our economic and legal systems that a parent corporation…is not liable for the acts of its subsidiaries.”[3]

However, a court may disregard the subsidiary as a separate entity from its parent company or shareholders under certain circumstances—a process known as veil piercing. Because of the importance of the notion of separate legal entity, veil piercing is the exception rather than the rule in all jurisdictions.[4] Most state legislatures have not explicitly addressed veil piercing, leaving the power to determine the standard of veil piercing to the courts.[5] In contrast, West Virginia in 2022 amended its statute to provide explicit guidance for veil piercing in light of pre-existing case law.[6]

Kubican v. The Tavern had binding precedential value on West Virginia veil piercing standards before the state’s Uniform Limited Liability Company Act was amended by the state legislature.[7] West Virginia Code provides that “any question of law…may, in the discretion of the circuit court in which it arises, be certified by it to the Supreme Court of Appeals for its decision.”[8] Utilizing the mechanism, the Circuit Court of West Virginia in 2012 asked the West Virginia Supreme Court of Appeals the fundamental question on veil piercing of LLCs: is it allowed?[9] The Circuit Court’s certification question stated: “Does West Virginia’s version of the Uniform Limited Liability Company Act, codified at W. Va. Code § 31B el seq., afford complete protection to members of a limited liability company against a plaintiff seeking to pierce the corporate veil?”[10] The circuit court submitted the answer of yes, that members of LLCs are completely protected and the veil cannot be pierced.[11]

The Supreme Court of Appeals disagreed, writing that because of the “solely” language that exists in the statute, the legislature implicitly “left intact the prospect of an LLC member or manager being liable on grounds that are not based solely on a person’s status as a member or manager of an LLC.”[12] The court subsequently reasons that allowing veil piercing would follow the reasoning of other states which have interpreted similar statutes and that a blanket rejection of the remedy of veil piercing would be detrimental to the goal of preventing injustice.[13]

In 2022, the state legislature amended the Uniform Limited Liability Company Act to give guidance towards veil piercing. Mentioning explicitly that it is the legislature’s intent to modify the applicability of the corporate veil piercing analysis adopted in Kubican, the amended act details that veil piercing for members and managers of LLCs should only be applied when “(1) the company is not adequately capitalized for the reasonable risks of the corporate undertaking and (2) the company does not carry liability insurance coverage for the primary risks of the business, with minimum limits of $100,000 liability insurance, or such higher amount as may be specifically required by law.”[14] While the amended provision reducing the opportunity for veil piercing has not been cited in any case since the amendment came into effect on June 10, 2022, future courts that apply West Virginia state law will have to abide by this heightened standard.

While well-managed companies are usually adequately capitalized and are insured against professional misconduct and mismanagement,  precluding veil piercing if these two conditions are met could still result in inequitable situations. For example, broker-dealers operating through an LLC may pitch stocks using false information to unsuspecting investors. Assuming no special professional insurance is required for broker-dealers, the amount that they potentially can defraud from investors greatly exceed the minimum $100,000 liability insurance, which would lead to an inequitable result. Because future courts could not rule in favor of veil piercing even when the LLC operated under fraudulent circumstances if the above two elements are not met, fraudulent broker-dealers and investment advisers may increasingly want to choose to become incorporated in West Virginia, where they will be insulated from personal liability while their misconduct could potentially reap significant benefits.

Compared to West Virginia, most state legislatures and courts employ more measured approaches, emphasizing that veil piercing is an equitable tool that may be used in situations of fraud.[15] A utilitarian explanation for the measured approach of most states may be that a state’s willingness to pierce the veil is not a determinative factor in corporations’ decision in selecting their state of incorporation. Commentators list tax benefits, privacy, expediency, and a well-respected court system as the main reasons why Delaware is a popular choice for incorporation.[16] The state law and court system’s stance on veil piercing may be a secondary consideration for businesses, but a bundle of supporting policies will be more likely to move the needle.

 

[1] See H. Ballantine, CORPORATIONS §122, at 293 (rev. ed. 1946); 1 W. FLETCHER, CYCLOPEDIA OF CORPORATIONS §25, at 100 (rev. ed. 1974).

[2] DEL. CODE ANN. tit. 6, § 18-303(a).

[3] Dole Food Co. v. Patrickson, 538 U.S. 468 (2003); United States v. Bestfoods, 524 U.S. 51, 61 (1998).

[4] Johnson v. Koplovsky Foods, Inc., 5 F. Supp. 2d 48, 54 (D. Mass. 1998).

[5] Fredric J. Bendremer, Delaware LLCs and Corporate Veil Piercing: Limited Liability has its Limitations, 10 Fordham J. Corp. & Fin. L. 385 (2005).

[6] W. Va. Code Ann. § 31B-3-303 [2022].

[7] Kubican v. The Tavern, LLC, 752 S.E.2d 299 (2013).

[8] W. Va. Code Ann. § 58-5-2 (West).

[9] Kubican v. The Tavern, LLC, No. 11-C-231-2, 2012 WL 8523515 (W.Va.Cir.Ct. Apr. 16, 2012).

[10] Id. W. Va. Code § 31B(a) reads: “A member or manager is not personally liable for a debt, obligation, or liability of the company solely by reason of being or acting as a member or manager nor for fines, fees or penalties individually assessed against another member or manager for acts unrelated to the business of the limited liability company.” W. Va. Code Ann. § 31B-3-303 [1996].

[11] Kubican v. The Tavern, LLC, No. 11-C-231-2, 2012 WL 8523515 (W.Va.Cir.Ct. Apr. 16, 2012).

[12] Kubican v. The Tavern, LLC, 752 S.E.2d 299 (2013), superseded by statutory amendment, W. Va. Code Ann. § 31B-3-303 [2022].

[13] Id. at 305.

[14] W. Va. Code Ann. § 31B-3-303 [2022].

[15] Pepsi-Cola Bottling Co. v. Handy, 2000 Del. Ch. LEXIS 52; Cleo Realty Assoc., L.P. v Uptown Birds, LLC, 135 A.D.3d 432; Pearl v. Shore, 17 Cal. App. 3d 608, 95 Cal. Rptr. 157 (Ct. App. 1971).

[16] Chauncey Crail et al.,Why Incorporate In Delaware? Benefits & Considerations, Forbes Advisor (Aug. 7, 2022,), https://www.forbes.com/advisor/business/incorporating-in-delaware/.