AINsight: Piercing the Aircraft LLC Veil

 - September 14, 2018, 6:24 AM

Aircraft owners who form limited liability companies (LLCs) typically believe that this structure will shield them from personal liability. However, that reasonable expectation could be incorrect given a recent Texas Supreme Court decision in Texas v. Morello (Morello).

In Morello, the sole member of an LLC found that his LLC did not protect him from personal liability for his and its violations of the Texas Water Code. While unrelated to aviation, this ruling also could affect members and others standing behind LLCs that own aircraft. Morello could hand the FAA, as well as other state and federal governmental agencies, a powerful tool to levy fines and penalties on LLCs, their pilots, members, and other officials for violations of the Federal Aviation Regulations (FARs).

This point is illustrated by referring to one of the most common violations of the FARs: illegal operations of an aircraft in an LLC that is a “flight department company,” meaning a company formed solely to own and operate an aircraft without any other business function. Perhaps of greater concern, people who make claims for personal injury, death, or property damage related to aircraft might consider how to leverage Morello as part of a litigation strategy in which they make high-dollar liability claims against members, managers, pilots, and others behind the LLC.

As background, LLCs statutes exist in all U.S. states. An LLC affords its members and managers a “shield” against personal liability for the LLC's debts, obligations, and liabilities. Each state statute differs in some ways, but all of them make LLC members personally liable for their wrongful actions under a principle referred to as “piercing the corporate veil” (or here, the “LLC shield”). Certain LLC statutes create significantly fewer barriers to piercing the LLC liability shield, such as those in Maryland, Massachusetts, and California. Ironically, Texas adopted an LLC law that strongly shields members.

Two long-existing methods to pierce the LLC shield highlight ways to incur personal liability. First, members or managers might be held individually liable for their “tortious” conduct (a legal term that means a “wrong” committed by the individual). Torts include defrauding an aircraft buyer, even if the conduct was undertaken or condoned by the member while acting individually or in his or her official capacity as an agent for the LLC.

Second, a court can pierce the LLC shield and impose personal liability on a member when he or she treats the LLC as the member’s “alter ego.” An alter-ego structure can sometimes be identified when the single member figuratively puts the LLC “on the shelf,” ignoring LLC formalities and, among other elements, commingles his/her money with LLC funds—as if the LLC did not exist. Fortunately, few courts impose personal liability on members just for failing to follow the formalities.

But the Morello case seems to provide a third and apparently new way to hold an LLC’s members and others personally liable. Although plaintiff Morello conducted all business of the LLC, he argued that the robust LLC shield under the Texas statute protected him from personal liability for the regulatory violations by his LLC.

The court rejected Morello’s arguments and found him personally liable for civil penalties levied by the Texas environmental agency, even though he acted in his official capacity as an agent (employee) of his LLC. In a technical interpretation of the Water Code, the court refused to let Morello hide behind his LLC when the violated statute contemplated that a “person” could be held directly liable for the violation.

In the context of the highly regulated private aviation industry, it is a short step for the FAA to apply the court’s approach to violations of the FARs, at least in Texas, especially where a “person” in the FARs generally includes individuals and LLCs in an analogous manner to Morello.

To illustrate, consider the following common flight department company scenario. An individual (member) creates a single-purpose LLC—let’s call it Owner LLC—to own and operate a business aircraft. The member exclusively manages and owns Owner LLC and bypasses all LLC formalities. He personally makes all decisions about the aircraft, pilots, operations, and maintenance. He transfers cash into the LLC to pay costs of ownership and operation of the Owner LLC aircraft.

In this situation, taking a page out of Morello’s playbook, the FAA could pierce the LLC shield and levy civil fines/penalties on both the LLC and its member for operating a flight department company in violation of the FARs. The violations consist, in part, of the LLC failing to hold an appropriate air carrier certificate and for unlawfully “compensating” the LLC for illegal charter/commercial flights.

In these actions, the member risks personal liability under Morello whether he or she acts individually or in an official capacity for the LLC. Further, the wrongful acts of the true owner/member, who treats the LLC as an alter ego, could also increase the potential exposure of the member. The violations might encourage others, if the facts seem right, to seek damages for personal injury or property damage based in part on the FAR violations.

An LLC owner might suggest that the remedy for these risks is buying liability insurance. However, it is rare that insurance covers fines or civil penalties, and a serious violation of the FARs could even cause an insurance company to disclaim coverage or reserve its rights not to pay for liability or property damage claims. In short, LLC members, managers, and pilots should have no illusions that, under Morello, they could potentially face personal, uninsured liability for violations of the FARs, without even considering pre-existing personal liability theories.

LLC members typically don’t worry about personal liability if an LLC owns their private aircraft. And they need not be overly concerned about Morello or the FAA relating to the LLC personal liability exposure if, in general, they do not treat their LLCs as alter egos, avoid tortious behavior, and comply with the FARs, including structuring LLC functions properly to avoid flight department company status.

But a regulatory compliance audit now might save an LLC owner from stinging FAA civil fines/penalties for operating a flight department company or violating other FARs, not to mention exposure to liability claims for personal injury or property damage. It should not be too hard to get the compliance right, but getting it wrong or ignoring compliance could take LLC members into an expensive and avoidable morass.

Note: The LLC issues covered in this blog do not constitute, and should not be relied on or construed as, legal advice of any kind. Most cases and LLC structures require extensive legal analysis. Each person should consult knowledgeable counsel in all matters covered by, or related to, this blog.

David G. Mayer is a partner in the global Aviation Practice Group at Shackelford, Bowen, McKinley & Norton, LLP in Dallas, which handles worldwide private aircraft matters, including regulatory compliance, tax planning, purchases, sales, leasing and financing, risk management, insurance, aircraft operations, hangar leasing and aircraft renovations. Mayer frequently represents high-wealth individuals and other aircraft owners, flight departments, lessees, borrowers, operators, sellers, purchasers, and managers, as well as lessors and lenders. He can be contacted at dmayer@shackelfordlaw.net, via LinkedIn or by telephone at (214) 780-1306.