Does the alter ego doctrine apply to limited liability companies (LLC)?

Does the alter ego doctrine apply to limited liability companies (LLC)?

Gardner vs. Dist. Ct. (Henderson Water Park, LLC) (Nev. Supreme Ct. – Nov. 22, 2017)

In this proceeding, the Supreme Court of Nevada considered whether seven managers of a limited liability company (LLC) were subject to suit for personal negligence as individual tortfeasors or under an alter ego theory of liability.

The Gardners, on behalf of their child L.G. (the Gardners), filed suit after L.G. suffered injuries resulting from a near-drowning at Cowabunga Bay Water Park in Henderson. The Gardners brought suit for negligence against Henderson Water Park, LLC, which does business as Cowabunga Bay Water Park (the Water Park), and its two managing members, West Coast Water Parks, LLC, and Double Ott Water Holdings, LLC (the member-LLCs). In turn, Orluff Opheikens, Slade Opheikens, Chet Opheikens, Shane Huish, Scott Huish, Craig Huish, and Tom Welch (the Managers) have an ownership interest in, or manage, the member-LLCs, and they also served on a management committee governing the Water Park.

Among other allegations in their initial complaint, the Gardners alleged the negligence of the Water Park and member-LLCs contributed to L.G.’s injuries because of the Water Park’s inadequate staffing of lifeguards. After taking depositions, the Gardners moved for leave to amend their complaint to add the Managers of the Water Park as individual defendants. Specifically, the Gardners sought to assert direct claims for negligence against the Managers in their individual capacities, and they sought to plead allegations supporting an alter ego theory of liability in order to pierce the corporate veil of the Water Park and the member-LLCs to reach the assets of the Managers. In support of their motion to amend their complaint, the Gardners quoted deposition testimony of one of the Managers stating the Water Park did not operate with 17 lifeguards at the wave pool as required by the Southern Nevada Health District.

The district court denied the Gardners’ motion, concluding that amendment would be futile because the Managers were improper defendants. Specifically, the district court found that NRS 86.371 protected the Managers from any liabilities incurred by the various LLCs and Nevada’s LLC statutes contained no alter ego exception to the protection offered by NRS 86.371.

Did the district court abuse its discretion by denying the Gardners’ motion to amend their complaint?

In their petition, the Gardners challenge the district court’s denial of leave to amend their complaint. NRCP 15(a) provides that leave to amend a complaint should “be freely given when justice so requires.” See also Nutton v. Sunset Station, Inc., 131 Nev., Adv. Op. 34, 357 P.3d 966, 975 (Ct. App. 2015) (“The liberality embodied in NRCP 15(a) requires courts to err on the side of caution and permit amendments that appear arguable or even borderline, because denial of a proposed pleading amendment amounts to denial of the opportunity to explore any potential merit it might have had.”). Leave to amend, however, “should not be granted if the proposed amendment would be futile.” Halcrow, Inc. v. Eighth Judicial Dist. Court, 129 Nev. 394, 398, 302 P.3d 1148, 1152 (2013).

The district court determined amendment would be futile because the Managers were improper defendants under NRS 86.371 and the alter ego doctrine did not apply to LLCs. The Gardners argued the district court erred in relying on NRS 86.371 because the Gardners sought to assert tort claims against the Managers in their individual capacities. Additionally, the Gardners argued the district court erred in concluding the alter ego doctrine did not apply to LLCs. Thus, the Gardners sought a writ of mandamus compelling the district court to grant their motion to amend their complaint.

The limited liability company

The Supreme Court of Nevada explained that the LLC is a form of business organization in Nevada. See NRS Title 7, Chapter 86. The persons who own an LLC are its members. See NRS 86.081-.091. The members can manage the LLC themselves or they can appoint a manager or group of managers to manage the company. See NRS 86.071; NRS 86.291. Accordingly, the statutes distinguish between member-managed and manager-managed LLCs, and managers of a manager-managed LLC may, but need not, be members of the LLC. See NRS 86.291.

The Court noted that an LLC is typically “created to provide a corporate-styled liability shield with pass-through tax benefits of a partnership.” Weddell v. H20, Inc., 128 Nev. 94, 102, 271 P.3d 743, 748 (2012). An LLC “combines the flexibility of a contract-based form such as a partnership and the limited liability of a state-created form such as a corporation.” H. Justin Pace, Contracting Out of Fiduciary Duties in LLCs: Delaware Will Lead, but Will Anyone Follow?, 16 Nev. L.J. 1085, 1086 (2016). However, “[u]nlike limited partners, LLC members do not lose their limited liability for participating in control of the business.” Robert R. Keatinge & Larry E. Ribstein, Ribstein and Keatinge on Limited Liability Companies § 1.6 (2016 ed.); see also NRS 88.430.

The Court explained that pursuant to the statutes governing LLCs, “[u]nless otherwise provided in the articles of organization or an agreement signed by the member or manager to be charged, no member or manager of any limited-liability company formed under the laws of this State is individually liable for the debts or liabilities of the company.” NRS 86.371. Furthermore, NRS 86.381 provides that “[a] member of a limited-liability company is not a proper party to proceedings by or against the company, except where the object is to enforce the member’s right against or liability to the company.” Accordingly, “no member or manager is vicariously liable for the obligations of the LLC solely by reason of being a member or manager.” Keatinge & Ribstein, supra, § 1.5; see also Gardner v. Henderson Water Park, LLC, 133 Nev., Adv. Op. 54, 399 P.3d 350 (2017) (holding “that, pursuant to NRS 86.371 and NRS 86.381, a member cannot be personally responsible for the LLC’s liabilities solely by virtue of being a member”). Nevada’s statutes governing LLCs provide no exception for an alter ego theory of liability, unlike the statutes governing corporations. See NRS 78.747(1) (“[N]o stockholder, director or officer of a corporation is individually liable for a debt or liability of the corporation, unless the stockholder, director or officer acts as the alter ego of the corporation.”).

Direct claims against the Managers

The Gardners argued the district court erred in relying on NRS 86.371 because the Gardners sought to assert direct tort claims against the Managers.

The Court explained that pursuant to NRS 86.371, a manager cannot be personally responsible in a negligence-based tort action against the LLC solely by virtue of being a manager. As it noted in Gardner, however, the statutes limiting personal liability of members and managers of an LLC for debts and obligations of the LLC are not intended to shield members or managers from liability for personal negligence. The Court further explained that a plain reading of NRS 86.371 protects members and managers only from individual liability resulting from the debts or liabilities of the LLC, not liabilities incurred as a result of individual acts. Thus, the act of managing an LLC in and of itself cannot result in personal culpability because this notion would be in conflict with the manager’s limited liability.

However, the Court noted that the Gardners’ proposed amended complaint contained multiple allegations of individual negligence by the Managers concerning their direct knowledge and actions that threatened physical injury to patrons, including L.G. Specifically, the proposed amended complaint alleged that the Mangers, who had authority and control over the Water Park, owed personal duties to their patrons that they intentionally and willfully breached. Thus, the Gardners’ proposed amended complaint alleged that the Managers breached a duty owed to L.G. arising out of their individual capacities. See Cortez v. Nacco Material Handling Grp., Inc., 337 P.3d 111, 119 (Or. 2014) (indicating that a member “remains responsible for his or her acts or omissions to the extent those acts or omissions would be actionable against the member. . . if that person were acting in an individual capacity”). Therefore, the Court concluded that NRS 86.371 was not applicable, the amended complaint adequately stated a negligence claim against the Managers in their individual capacities, and the district court abused its discretion by denying the Gardners’ motion for leave to amend.

The alter ego doctrine

The Gardners also argued that the alter ego doctrine should apply to LLCs so that the Gardners can pierce the veil of the Water Park and its member-LLCs to reach assets belonging to the Managers.

The Court explained that states across the nation have consistently applied the alter ego doctrine to LLCs. Montgomery v. eTreppid Techs., LLC, 548 F. Supp. 2d 1175, 1181 (D. Nev. 2008) (recognizing that federal and state courts have regularly applied corporate laws for piercing the corporate veil under the alter ego doctrine to LLCs). Many states have enacted LLC statutes that expressly apply the alter ego doctrine to LLCs. California Corporations  Code § 17703.04(b) (“A member of a limited liability company shall be subject to liability under the common law governing alter ego liability . . .”); Colorado Revised Statutes § 7-80-107(1) (applying caselaw that interprets the conditions and circumstances under which the corporate veil of a corporation may be pierced under Colorado law to LLCs).

Other courts, however, have found the alter ego doctrine applies to LLCs absent an express statutory provision. BLD Prods., Ltd. v. Tech. Plastics of Or., LLC, No. 05-556-KI (D. Or. Dec. 11, 2006) (applying Oregon law and finding the veil-piercing doctrine may be applied to LLCs under the same circumstances in which it is applied to corporations); Westmeyer v. Flynn, 889 N.E.2d 671, 678 (III. App. Ct. 2008) (holding piercing the corporate veil applies to an LLC and the Illinois LLC Act “does not bar the other bases for corporate veil piercing, such as alter ego, fraud or undercapitalization”); Howell Contractors, Inc. v. Berling, 383 S.W.3d 465, 467-69 (Ky. Ct. App. 2012) (recognizing piercing of veil for an LLC in cases of fraud, illegality, or other unlawfulness); Bottom Line Equip., LLC v. BZ Equip., LLC, 60 So. 3d 632, 636 (La. Ct. App. 2011) (“The theory of piercing the corporate veil applies to limited liability companies and is not limited to corporations.”).

The Court noted that it had “assume[d], without deciding, that the [alter ego] statute applies [to LLCs].” See Webb v. Shull, 128 Nev. 85, 92 n.3, 270 P.3d 1266, 1271 n.3 (2012). Several other courts have made the same assumption. See, e.g. ,Volvo Constr. Equip. Rents, Inc. v. NRL Rentals, LLC, 614 F. App’x 876, 878 n.1, 880 (9th Cir. 2015) (“assum[ing], without deciding, that § 78.747 governs the scope of LLC member liability in Nevada,” but ultimately holding the LLC members were not personally liable under the alter ego theory); Pharmaplast S.A.E. v. Zeus Med. Holdings, LLC, No. 2:15-cv-002432-JAD-PAL (D. Nev. Mar. 14, 2017) (assuming, without deciding, “that the alter-ego principles that permit courts to pierce corporate veils also permit them to pierce LLC veils in Nevada,” but ultimately dismissing the claims brought under the alter ego theory); but see In re Giampietro, 317 B.R. 841, 846 (Bankr. D. Nev. 2004) (recognizing that whether the alter ego doctrine applies to LLCs in Nevada is a question of first impression and predicting “it highly likely that Nevada courts would recognize the extension of the alter ego doctrine to members of limited liability companies”).

The Court explained that the alter ego doctrine is a judicially created doctrine that the Nevada Legislature codified for corporations in 2001. See NRS 78.747. Before it was codified, it recognized that “the essence of the alter ego doctrine is to do justice whenever it appears that the protections provided by the corporate form are being abused.” LFC Mktg. Grp., Inc. v. Loomis, 116 Nev. 896, 903, 8 P.3d 841, 845-46 (2000). Nevada’s LLC statutes were enacted in 1991, prior to the Legislature’s codification of the corporate alter ego doctrine. The Legislature contemplated that LLCs would be subject to the same then judicially applied doctrine of alter ego as corporations.

The Court further explained that nothing in the Legislature’s codification of the alter ego doctrine for corporations indicated that the Legislature was considering the LLC statutes or that it intended, by negative-implication, to apply the alter ego doctrine to corporations, but not LLCs. Therefore, the Court declined to interpret the Legislature’s enactment of NRS 78.747 as, by omission, precluding the application of the alter ego doctrine to LLCs.

The Court determined that as recognized by courts across the country, LLCs provide the same sort of possibilities for abuse as corporations, and creditors of LLCs need the same ability to pierce the LLCs’ veil when such abuse exists. See Giampietro, 317 B.R. at 846 (“The varieties of fraud and injustice that the alter ego doctrine was designed to redress can be equally exploited through limited liability companies.”). Thus, the Court held that the alter ego doctrine applies to LLCs and the district court erred in denying the Gardners’ motion to amend their complaint to allege that the Managers were subject to liability through the alter ego doctrine.

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