Although Cooperative Claimed No Knowledge of LLC When Issuing Loan, LLC Member Was Not Personally Liable for Debt

The Iowa Court of Appeals has found that a member of an LLC was not personally liable for the debt of the LLC, even though the lender contended that it had extended credit to a partnership and not to the LLC.

The defendant and his business associate formed an LLC in November of 2004 to operate a farm.  Both of them were members of the LLC.  The LLC purchased farmland and equipment, and the members also used their individually-owned equipment to support the operation.

About a week before the LLC filing, the defendant’s associate purchased supplies for the business on credit from the local cooperative. The associate stated that he did not fill out a credit application, and he did not remember if he told the cooperative that the credit was for “HP Farms LLC” or merely for “HP Farms.” Neither the associate nor the defendant signed a personal guaranty for the loan. During the next year and a half, the cooperative continued to extend credit to the farming business, and the business paid off portions of its credit account (including all of the debt accrued prior to the LLC filing) with checks from “HP Farms, LLC.” The account became delinquent in 2006, and in 2008, the defendant’s associate filed a confession of judgment for $226,996, the amount of the balance of the account. In September of 2011, the associate and the cooperative entered into a settlement under which they agreed that the associate would pay $100,000 to the cooperative and would cooperate with the cooperative’s lawsuit against the defendant in exchange for a release of personal liability.  

The cooperative then filed an action against the defendant and against the defendant “doing business as ‘HP Farms.’” The lawsuit sought to recover the balance of the account from the defendant under a theory of joint and several liability that characterizes a partnership relationship. In its action, the cooperative alleged that it was not aware that the defendant was operating as an LLC, but only as a business partner with the associate under the name “HP Farms.” The cooperative was unable to produce a loan application, but it argued that the application revealed only a partnership interest. The cooperative’s billing statements were sent to “HP Farms,” not “HP Farms, LLC.” The cooperative also alleged that even if the credit was extended to the LLC, the court should pierce the veil because “the LLC was a mere shell and was used by the defendant to commit fraud and promote injustice.”

The district court entered judgment in favor of the defendant, finding that there were no “exceptional circumstances” necessary to pierce the corporate veil of “HP Farms, LLC” and that there was no evidence that the defendant agreed to be personally liable for the debt.

In affirming, the Court Appeals found that substantial evidence supported the district court’s ruling that exceptional circumstances did not exist to pierce the corporate veil of the LLC. The evidence supported findings that (1) the LLC was not undercapitalized; (2) the LLC had separate books; (3) the LLC’s finances were separate from the members’ individual finances; (4) the LLC did not pay the obligations of the members; (5) the LLC was not used to promote fraud or illegality; and (6) the LLC was not merely a sham. The fact that the LLC may not have held meetings was an insufficient reason to pierce the veil because the failure to “observe any particular formalities” was not a ground for imposing individual liability on a member pursuant to Iowa Code § 489.304(2).

The court also found that substantial evidence supported the district court’s determination that the defendant was not individually liable for the debt to the cooperative based on fraud in the inception. When the cooperative first extended credit in 2004, it had no contact with the defendant, and it did not receive any assurances from the defendant. At no point did the cooperative rely on or ask for a financial statement for the account it named “HP Farms.” As such, the defendant, as an individual, was not a party to the extension of credit.

This case highlights the importance of proper procedures and documentation for all extensions of credit. This litigation could likely have been avoided had the cooperative followed proper procedures and fully documented these loan transactions. Although this decision was favorable to the defendant, borrowers should always ensure that their loan accounts are correctly opened in the name of their corporate entity. Had the cooperative been able to produce an application, this case may have been decided differently.