Uniform Protected Series Act
Caution State Law Variances!
SECTION 402. CLAIM SEEKING TO DISREGARD LIMITATION OF LIABILITY.
JayNote: Section 401 giveth protection, and § 402 taketh away protection in no insubstantial part.
(a) Except as otherwise provided in subsection (b), a claim seeking to disregard a limitation in Section 401 is governed by the principles of law and equity, including a principle providing a right to a creditor or holding a person liable for a debt, obligation, or other liability of another person, which would apply if each protected series of a series limited liability company were a limited liability company formed separately from the series limited liability company and distinct from the series limited liability company and any other protected series of the series limited liability company.
Reporter's Comment to Subsection (a) – This provision avoids a court having to reinvent the wheel when considering piercing, affiliate liability, and related theories in the context of a series limited liability company and its protected series. The provision encompasses outside reverse piercing claims (to the extent a state allows such claims) but by its terms does not address inside reverse piercing claims. A successful inside reverse pierce does not disregard a liability shield but rather permits an entity's owner to enjoy and exercise a right belonging to the entity or vice versa.
The provision's references to particular categories of "principles of law and equity" should not be interpreted as limiting the effect of Uniform Limited Liability Company Act (2006) (Last Amended 2013), Section 111 (stating that "[u]nless displaced by particular provisions of this ACT, the principles of law and equity supplement this ACT") (brackets in original) or of comparable provisions in other limited liability company acts. This provision refers to a subset of those principals but only to determine how to apply the subset's principles in a novel context.
JayNote: In English, § 402(a) says that if a claimant could assert a theory* to disregard the liability shields of an ordinary non-series LLC, then that same theory could be used to disregard the liability shields of a protected series or the series organization.
*Other than the mere failure to observe formalities, which is treated separately in ¶ (b) next following.
(b) The failure of a limited liability company or a protected series to observe formalities relating to the exercise of its powers or management of its activities and affairs is not a ground to disregard a limitation in Section 401(a) but may be a ground to disregard a limitation in Section 401(b).
Reporter's Comment to Subsection (b) – Piercing is based on a factor test. In the corporate context, two of the most prominent factors are the disregard of governance formalities and disregard of economic separateness between the entity and owners. However, "[i]n the realm of LLCs, [the governance] factor is inappropriate, because informality of organization and operation is both common and desired." Uniform Limited Liability Company Act (2006) (Last Amended 2013), Section 304(b), cmt. Some limited liability company acts expressly negate governance informality as a piercing factor entirely, and some courts have discarded or downgraded the factor for LLC piercing claims. See, e.g., Uniform Limited Liability Company Act (2006) (Last Amended 2013), Section § 304(b) ("The failure of a limited liability company to observe formalities relating to the exercise of its powers or management of its activities and affairs is not a ground for imposing liability on a member or manager for a debt, obligation, or other liability of the company.").
Consistent with both the 2006 and 2013 versions of the uniform act, this provision applies the same approach to the vertical shields provided by this act. The provision does not, however, apply to the horizontal shields. To do so would undercut the inducement to good recordkeeping provided by Sections 301 and 404.
JayNote: That general rule of § 402(a) comes with a sizeable caveat found in the following § 402(b), which is that the mere failure of either the series organization or a protected series to follow formalities does not create a ground to disregard the liability shields.
(c) This section applies to a claim seeking to disregard a limitation of liability applicable to a foreign series limited liability company or foreign protected series and comparable to a limitation stated in Section 401, if:
JayNote: Paragraph (c) may be characterized as a choice-of-law provision that requires § 402 to be used in certain situations involving a series LLC formed in another jurisdiction.
(1) the claimant is a resident of this state or doing business or registered to do business in this state; or
(2) the claim is to establish or enforce a liability arising under law of this state other than this ACT or from an act or omission in this state.
Reporter's Comment to Subsection (c) – Section 401(a) and (b) state limitations of liability comprising respectively the vertical and horizontal shields. Claims "seeking to disregard" such limitations of liability are traditionally referred to as "piercing" claims or, in some circumstances, "affiliate liability" claims. Section 402(a) applies an enacting state's existing jurisprudence on piercing and affiliate liability to domestic series limited liability companies and domestic protected series as "if each protected series of the series limited liability company were a limited liability company: (1) organized separately from the company that established the protected series; and (2) distinct from the company and any other protected series of the company."
In contrast, this provision–i.e., Subsection (c)–applies an enacting state's jurisprudence on piercing and affiliate liability to foreign series limited liability companies and foreign protected series in carefully and narrowly delineated circumstances. This stance is unusual but is neither novel nor, in the circumstances, unwarranted.
Virtually all, if not all, limited liability company acts provide that the law of the foreign limited liability company's jurisdiction of formation governs piercing claims. See, e.g., Uniform Limited Liability Company Act (2006) (Last Amended 2013), Section 901(a)(2). But the situation seems to be the result of "path dependence" on an initially unexplained choice. The approach of limited liability company acts reflects the approach of the Uniform Limited Partnership Act in effect in most states when limited liability company acts were first being enacted. See Uniform Limited Partnership Act (1976 with 1985 amendments) § 901(i) (stating that "the laws of the state under which a foreign limited partnership is organized govern its organization and internal affairs and the liability of its limited partners").
It is unclear why the Uniform Limited Partnership Act codified what had previously been a rule of common law. According to an official comment to the 1985 version, the Uniform Limited Partnership Act, Section 901 "first appeared in the 1976 Act." However, the comment provides no explanation for this variation from the original Uniform Limited Partnership Act of 1916, which relied on common law choice of law principles for both the "internal affairs doctrine" and piercing claims. See Se. Texas Inns, Inc. v. Prime 36 Hosp. Corp., 462 F.3d 666, 672-76 (6th Cir. 2006) (discussing at length which state law to apply to a claim to pierce the veil of a limited partnership, making no reference to the limited partnership statute of the forum state [Tennessee], determining that "the choice-of-law question is not outcome-determinative in this case," and therefore not deciding the issue).
In the corporate context, the choice of law has long been a matter of case law. See
Dassault Falcon Jet Corp. v. Oberflex, Inc., 909 F. Supp. 345, 348-49 (M.D.N.C. 1995);
Restatement (Second) of Conflict of Laws (1971) § 307 ("The local law of the state of
incorporation will be applied to determine the existence and extent of a shareholder's liability to the corporation for assessments or contributions and to its creditors for corporate debts.").
Although the Restatement might suggest the rule is invariable, venerable Supreme Court precedent allows for exceptions. Pinney v. Nelson, 183 U.S. 144, 150, 22 S. Ct. 52, 55, 46 L. Ed. 125 (1901) ("Contracting with reference to the laws of that state [not the state of incorporation] [the shareholders] …must be assumed to know the provisions of those laws; that by them a personal liability was cast upon the stockholders in corporations formed under the laws of the state, and that that same liability was also imposed upon the stockholders of corporations formed under the laws of other states and doing business within California.").
Given the novel concept of one legal person existing under the aegis of another legal person and the novel construct of a horizontal shield, the Uniform Law Commission chose to revert to common law flexibility rather than merely to reiterate a codification that entered the law of unincorporated organizations without explanation and whose rationale has never been fully explored.
Reporter's Comment to Subsection (c)(1)-(2) – These provisions limit subsection (c) to matters in which an enacting state has a substantial and direct interest – whether due to the nature of the claimant, the facts giving rise to the claim, the law providing the legal basis for the claim, or some combination.
Legislative Note: Subsection (b) parallels Uniform Limited Liability Company Act (2006) (Last Amended 2013), Section 304(b), but solely with regard to vertical shields. If an enacting state's limited liability company act contains a comparable concept but uses different language, the state should revise subsection (b) accordingly. If an enacting state's limited liability company act does not contain a comparable concept, the state should omit subsection (b).
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