Are single-member LLCs less secure than multi-member LLCs?

Jeff Axup Sr. Manager, Palo Alto UX Design Research Group at Bosch

December 3rd, 2013

I recently received some advice from an accountant to change my multi-member LLC to a single-member to simplify taxes (disregarded entity, can be done on personal return, cheaper).

However, I have also heard that the corporate veil can be pierced more easily for single-member LLCs and that it is stronger to be multi-member. The primary purpose of my LLC is to protect my personal assets in the event of being sued over one of my business ventures.

I am incorporated in Delaware.
Does anyone know of actual cases where the corporate veil has been removed due to being single-member? Is this common?
It is logical to assume that not all businesses have multiple members and that sole-owners would still want protection against malicious customers but I'm not sure the law agrees with that.

Any opinions/data/stories/advice on this?

Scott Milburn Entrepreneurial Senior Executive and Attorney

December 4th, 2013

Jeff, piercing the veil is a legal term that involves a determination by a court that the corporate entity can be ignored and the individual held personally liable for what would otherwise be corporate debts. As a high level overview, it generally happens only when the owners of the corporation ignore the corporate formalities and run the business like it is their own personal business.

The check deposit activity that Luis describes is one aspect of the types of actions a court examines. Others include failure to maintain corporate formalities such as holding board and shareholder/member meetings, commingling of funds, paying personal expenses with corporate funds, etc.

A single member LLC is not inherently more likely to have the veil pierced. On the other hand, the owner of a single member LLC may be more likely to fail to follow the corporate formalities, and may be more likely to engage in behavior that a court would consider as evidence that the veil should be pierced, because that person is not accountable to anyone else. For example, if a major corporate decision requires the approval of the members, a multiple member LLC may be more likely to actually hold a meeting to discuss the subject and prepare formal minutes documenting the decisions that were made at the meeting. The single member LLC owner may just make the decision in his or her mind and then act accordingly, with no record of the action.

So, a single member LLC is fine, as long as you follow the rules and truly treat it as a separate legal entity.

Javier Gomez

December 4th, 2013

What your acct was talking about is that single member entities are taxed like sole proprietorships. In other words, your llc is disregarded for tax purposes unless you checked a certain box when you filed, but legally (civil cases/contract) the business is a seperate entity. Still, you either are or aren't a single member LLC. If you're collecting all the profits, would save a few bucks each year on tax prep.

Luis Avila Owner/Fullstack Architect at IdeaNerd LLC

December 4th, 2013

The corporate veil can only be pierced by you if you're a single member disregarded LLC.

An example of piercing the veil... You lend your brother $100. He gives you a check payable to Jeff Axup. You deposit the check to you corporate (LLC) account. Or vice versa.... your client pays your corp.. you deposit the check to your personal account.

Other example... you use a personal credit card to pay for business expenses and vice versa.

Multi-member LLCs can also pierce the corporate veil in this way. It's not inherently safer to be a multi-member LLC.

hope that help

Anonymous

December 4th, 2013

Scott Milburn: I'm the single member of a single-member LLC (and it's a disregarded entity for tax purposes too). I don't quite understand what you were suggesting when you wrote "if a major corporate decision requires the approval of the members, a multiple member LLC may be more likely to actually hold a meeting to discuss the subject" etc. Holding a meeting with myself and preparing formal minutes seems rather Alice-in-Wonderland-ish. It's difficult to believe any court would demand such a thing. Presumably, some more straightforward system of corporate record-keeping would suffice. But what, exactly? Notarized statements to the effect that on such-and-such a date, I, Ralph Haygood, the sole member of Haygoodness L.L.C., decided to blah blah blah? And, by the way, just what constitutes a major corporate decision in this context? Obviously, selling the corporation, buying another corporation, or adding a member would qualify, but what else?

Scott Milburn Entrepreneurial Senior Executive and Attorney

December 4th, 2013

Ralph, I know it seems silly to hold a meeting with yourself, talk to yourself, and agree with yourself on something (sounds like some of those people we see standing on street corners all day), but that is essentially how the documentation should appear. Indeed, you should really have an occasional written document that says the member of the LLC has determined that the LLC should do x, and sign it as member.

Ideally, you would have similar documentation to what you would expect with a multi-member LLC. At a minimum, there should be an annual meeting, just like corporations are required to have an annual meeting of shareholders.

Your LLC agreement may specify what actions require approval of the member(s). Otherwise, think about what you would expect to have agreed in writing if there were multiple members, e.g. decisions about banking, major hires, investment, obviously M&A.

O.Shane Balloun Attorney / Shareholder at Balloun Law Professional Corporation

February 16th, 2014

(Obligatory disclaimer: I am an attorney but not your attorney for the purposes of this legal information. This is not legal advice.)

There are two types of piercing of the corporate (or LLC) veil that may apply. My guess is that what you heard applies to so-called reverse piercing.

Piercing the corporate veil

Regular piercing of the corporate (LLC) veil occurs when the court, as a matter of public policy, determines that (a) the company did not maintain sufficient formal separation between its own activities and the activities of the owner(s) or (b) that the owner (principal) acted so egregiously that the company and the principal should be treated as one in the same for purposes of liability of the principal. The corporation or LLC is supposed to protect the owner(s) from personal liability if the LLC incurs liability. But if the owners mix personal and business funds, or if the principal acts in manifest bad faith toward a third-party, or if the company fails to observe proper formalities, a court may "pierce" the veil and hold the owner(s) liable.

Sole-member LLCs are either at greater or much less risk for having their veils pierced, depending on the character and activities of the owner. If the owner is diligent, fastidious, and careful, the sole-member LLC will be less likely to see its veil pierced, and vice versa.

Reverse piercing

Reverse piercing of the corporate veil occurs when one of the owners is already liable to a third party for an event that may have nothing to do with the company. Imagine an LLC member gets into a car accident and his insurance is insufficient to cover the losses to the victim. The member's ownership interest in the LLC is technically the personal property of the member and can be sought after by the victim to compensate the victim for her losses.

Now, of course, if the victim is able to execute upon and foreclose the member's interest in the LLC, this would significantly disrupt the business (or destroy it). Depending on the state, the victim may not be able to foreclose management rights, but will be able to foreclose economic rights and demand continuing updates about the internal operation of the business with few privacy protections. Some states protect LLCs from this by making a charging order the only remedy that a third-party can seek against an LLC member with respect to the LLC. A charging order is something akin to a lien against the member's future distributions and comes in the form of a command (order) by the LLC's home state's court. The charging order tells the LLC that when it distributes money to members, it must do so to the victim on behalf of the liable-member's behalf until the victim is paid, but the third-party victim is not entitled to any other rights or information about the LLC. It preserves the rights of the third-party to be paid (maybe, if the LLC makes distributions to its members in the future), but preserves the rights of the business to proceed relatively unfettered by third-party demands.

The policy behind this is to protect the LLC from being disrupted by the personal activities of one of the members, and to protect co-founders.

As you can imagine, some states make a distinction between sole-member LLCs and multi-member LLCs, because presumably the protections necessary for multi-members LLCs. So some states' courts will be more reluctant (or will be precluded by statute) from foreclosing memberships in LLCs on behalf of third parties when the LLC has two or more members but they will dissolve the LLC on behalf of the victim if the LLC is owned by one person. California is one such state.

There are, however, three states that expressly protect LLCs from this sort of foreclosure and dissolution, even for sole-member LLCs: Wyoming, Delaware, and Nevada. I often recommend Wyoming LLCs (over Delaware or Nevada LLCs) for other reasons, but sole-member LLC founders should consider originating their LLCs in one of these three states and then qualifying them to do business in their states of residence/principal place of business. (Unrelated note: the LLC will still probably have to pay taxes to the state where its headquarters and principal place of business are located.)

O.Shane Balloun Attorney / Shareholder at Balloun Law Professional Corporation

February 16th, 2014

Correction:

As you can imagine, some states make a distinction between sole-member LLCs and multi-member LLCs, because presumably the protections necessary for multi-members LLCs are greater.

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