We counsel many owners of limited liability companies that the filing of a Certificate of Formation does note automatically protect the owners from person liabilities. There are a number of business practices, often referred to as the “corporate formalities” that should be followed.
A case from Iowa’s Court of Appeals illustrates this principle, in which the court affirmed the finding of a trial court that the owners of a limited liability company were personally liabile for $235,000 owed to a supplier. Keith Smith Co. v. Bushman, 873 N.W.2d 776(Table), 2015 WL 8364910(Table) (Iowa App., 2015).
The supplier claimed that the defendant was essentially a shell company with inadequate capitalization. The trial court agreed and the appeals court affirmed.
In the instant case, neither Duane Bushman nor Shirley Bushman provided any capital whatsoever for the start up of Farmer Grown Poultry. Its only revenue was a $2000 loan from a Bushman-related entity. As debts were incurred, Bushman-related entities would lend money to Farmer Grown Poultry for payment on its debts. Farmer Grown Poultry did not have any assets itself. Duane Bushman entered into a contract with Keith Smith, on behalf of Farmer Grown Poultry, to purchase hatching eggs. He entered into a contract that provided payment would be made to Keith Smith within 21 days of receiving the eggs. However, Farmer Grown Poultry, at best, would not receive any income for at least 10 weeks, when the birds could be processed and sold. Farmer Grown Poultry continued to accept eggs from Keith Smith in spite of the fact Custom Poultry Processing failed to become operational until December 2010. Farmer Grown made no attempt to request Keith Smith stop egg deliveries and seek another purchaser. This could have reduced Keith Smith’s loss.
The Court concludes the “corporate veil” of Farmer Grown Poultry, a limited liability company owned by Duane Bushman and Shirley Bushman, should be pierced and personal liability be imposed on Duane Bushman and Shirley Bushman.
To not hold the individual owners of the limited liability company personally liable, the appellate court held, “would promote an injustice to the creditor.”
A recent Iowa Court of Appeals case illustrates that limited liability is not an “automatic” benefit conferred upon business owners when creating an LLC. Specifically, the Iowa Court of Appeals determined that while business owners may set up a new entity (e.g. LLC), creation alone is not the only factor a court will assess when determining whether a business owner may be personally liable. In rendering its opinion, the Court identified six different factors a court may consider when determining whether to hold a business owner in an LLC personally liable:
Entrepreneurs and business owners often elect to create a formal business entity, such as a limited liability company (“LLC”), to shield themselves from personal liability. In other words, they create such an entity to ensure that if an adverse court judgment is entered in relation to the business’ activities (e.g. breach of contract; slip & fall; infringement, etc.), the judgment is solely collectible against the LLC and not against the individual owner(s) in their personal capacity. […]