Iowa Court of Appeals Says LLC Veil Improperly Pierced

On April 15, 2020, the Iowa Court of Appeals issued an opinion in a breach of contract case brought by a subcontractor against a business owner and his LLC to collect for work done during a building remodel. The court ruled that the district court incorrectly pierced the veil of the LLC and imposed personal liability on the LLC owner.

Background

The business owner, acting on behalf of his LLC, hired a general contractor to renovate an empty building, owned by his LLC, to include apartments as well as a brewery and restaurant. The construction company hired a subcontractor for various remodeling projects. This included providing and installing double doors for the front of the building. After the general contractor withdrew, the business owner began to work directly with the subcontractor. The parties did not have a written contract.

After some disputes regarding work quality, the LLC fell behind in payments. The subcontractor filed a mechanic’s lien against the property for the unpaid amount of $33,000. After the business owner made a partial payment, the subcontractor completed the work. The business owner sent several text messages, emails, and letters to the subcontractor reaffirming his intent to pay the remainder of the costs incurred but ultimately failed to do so. The subcontractor filed a lawsuit against the defendants for breach of contract and sought to hold the business owner personally liable for the damages. The defendants answered by denying that the subcontractor was entitled to recovery and alleging deficiency in work performed.

The district court awarded $17,708—plus interest and attorney fees—to the subcontractor, finding both the LLC and the business owner liable for the judgment. The defendants appealed.

Piercing the Veil

On appeal, the business owner claimed he should not have been held personally liable for any breach of contract. The court reviewed the applicable law and agreed. An LLC is “an entity distinct from its members.” Iowa Code § 489.104(1). Normally, a manager or member of an LLC is not responsible for the debts and liabilities of the company. However, under special circumstances, a court may “pierce the veil” of an LLC and hold a member or a manager individually liable. While no precise list exists, circumstances that warrant piercing the veil of an LLC include:

• It is undercapitalized,
• It is without separate books,
• Its finances are not separated from individual finances,
• It pays an individual’s obligations,
• It is used to promote fraud or illegality, or
• It is merely a sham.

See Ne. Iowa Co–Op. v. Lindaman, No. 13–0297 (Iowa Ct. App. 2014). The district court found the business owner did not prove the contractual relationship to be between the subcontractor and the LLC. Instead, the court found the relationship to be between the contractor and the business owner because he promised to pay the subcontractor through text messages and letters which did not contain the LLC’s name.

In reversing this decision, the Court of Appeals held that the burden to prove whether the veil was pierced was on the subcontractor. When the business owner made payments, it was from the LLC’s account. Additionally, the subcontractor acknowledged that the business owner acted as the building representative when working together. There was no evidence “the LLC was undercapitalized, lacked separate books, or finances, was promoting any fraud or illegality, or was a sham.” While the business owner did not use official letterhead, referred to himself in the first-person, and had a casual nature of communicating with the subcontractor, this was insufficient evidence to undermine the LLC’s legitimacy. Therefore, the subcontractor did not meet its burden demonstrating any special circumstances warranting a piercing of the veil.

Offset of Damages Due to Workmanship

The defendants also argued that the amount of damages awarded should be reduced due to the “undisputed deficiencies in the work performed.” The defendant’s main complaint was that the cosmetic look of the doors was never remedied. Evidence presented at trial showed that the contractor worked to fix any deficiencies that arose including fixing the doors when they would not stay unlocked. The Court of Appeals affirmed the district court’s rejection of an offset in damages finding that the defendant’s own delay in ordering the doors caused the project to be rushed.