A major driving factor in forming a corporation, limited liability corporation (“LLC”), or limited partnership is the creation of a distinct legal entity. With such a distinction in place, the entity enjoys limited liability and, thus, the shield of a “corporate veil.” With this protection, only the personal assets invested in the business are at creditors’ reach if the entity should fail to pay its debts. Nonetheless, an exception applies.[i] In limited circumstances, a court may allow an owner’s personal assets to be used to satisfy the entity’s debts using a process known as “Piercing the Corporate Veil.” Traditionally, a two-prong test is used to determine whether the corporate veil can be pierced. This test looks at (1) the presence of misuse of the entity’s form, including the commingling of assets and undercapitalization of the business, and (2) whether following a legal fiction can result in fundamental injustice.[ii] However, in Florida, when deciding whether to pierce a corporate veil, courts will only analyze the presence of fundamental injustice, using a test adopted in Dania Jai-Alai Palace, Inc. v. Sykes. In Sykes, the court asks whether “the corporation was organized or used to mislead creditors, or to perpetrate fraud upon them.”[iii] However, this narrow test could not have accounted for the issues that may arise today.
Following the COVID-19 pandemic, the U.S. experienced an exponential boom in entrepreneurship as Americans were starting their own businesses at unprecedented rates. Florida was no stranger to this surge, and in fact, between the years 2020 and 2023, the state witnessed a 41% increase in domestic LLC filings.[iv] Additionally, as of 2023, 3.1 million Florida businesses were small businesses.[v] Now, although “small” is defined by the U.S. Small Business Administration as having 0-500 employees, 99% of these small businesses are “true” small businesses, only having 0-19 employees.[vi] While this business explosion can be perceived as an economic triumph, celebrations should be short-lived when viewed through the lens of a business creditor. It is plausible to assume that a substantial majority of these businesses have been organized as LLCs or similar entities due to their widely known limited liability protection; however, it is likely that for most entities, their legal literacy ends there.[vii] So why does a proliferation of small businesses with a potential insufficiency in legal awareness create a cautionary landscape for Florida business creditors? Well, the veil-piercing standards in Florida severely limit their chances of getting paid.
Under Florida law, the corporate veil may not be pierced absent a showing of improper conduct, and a court must consider the following:
[Whether] the corporation was a mere device or sham to accomplish some ulterior purpose or is a mere instrumentality or agent of another corporation or individual owning all or most of its stock, or where the purpose is to evade some statute or to accomplish some fraud or illegal purpose.[viii]
While the implications of this standard would be easily discernible for larger small businesses with hundreds of employees, as they are often established by educated business individuals, at the advice of esteemed counsel, the same cannot be said for true small businesses created by an ordinary citizen. The combined intricate knowledge of the business and legal framework embedded within these larger small businesses leaves little room to infer that any improper conduct in the entity’s organization or course of business was not intentionally deceptive, used to purposely mislead creditors, or to perpetrate fraud upon them. Therefore, in these situations, it is conceivable to imagine the application of Florida veil-piercing law and the subsequent satisfaction of the entity’s debts to its creditors. However, the issue truly lies in the 3 million Florida small businesses with only 0-19 employees and little to no business or legal education.
Studies reveal that only 9% of small business owners have a background in business, and surprisingly, less than half hold a college degree. Moreover, less than 50% of small business owners utilize an attorney to prevent mishaps. Consequently, 65% of small businesses fail within their first ten years.[ix] When these figures are considered in light of Florida’s large number of small businesses, it underscores a significant risk to creditors in the state. When these businesses fail, business creditors have priority in repayment. Yet, a failed venture initiated by an ordinary citizen seeking to ‘be their own boss’ likely cannot satisfy these debts. While creditors may typically resort to veil-piercing, this option may not be readily available in Florida, as it is difficult to demonstrate that an average citizen—lacking business education or legal guidance—intentionally devised their entity as a mere sham to achieve ulterior motives or evade legal obligations. Often, these individuals who lack business education or legal guidance make inadvertent mistakes rather than engaging in purposeful misconduct. So, how may creditors be protected?
Although the ultimate determination of the presence of improper conduct rests on court interpretations, proactive measures can be instituted prior to legal proceedings to render instances of improper use more compelling against these types of owners. For instance, forming an LLC in Florida is relatively simple, quick, and inexpensive. This accessibility leads to individuals participating in ventures for which they may not be fully prepared. Nonetheless, in accordance with the ideals of free enterprise, starting a business should remain accessible, but measures could be implemented to ensure better preparedness, benefiting all parties involved. Namely, Florida may enact a mandatory course for those interested in establishing an LLC that defines characteristics of improper conduct, how they are analyzed, and lists the repercussions owners agree to face if they engage in such actions. Considering convenience, this course would be short, accounted for in the filing fee, and include the option to opt-out, with the caveat that in doing so, individuals agree to be held to the same standards.
On a larger scale, if a case involving the piercing of the corporate veil once again advances to the Florida Supreme Court, now challenging the narrow and rigid standard of purposeful improper conduct—particularly in the context of a true small business—the Court should reevaluate its approach. In doing so, it could refine its stance to ensure creditors can secure rightful repayment in such circumstances. Business creditors, such as banks, are often perceived as financial powerhouse, unlikely to need the court’s sympathy for monetary losses that are relatively insignificant in comparison to their substantial financial reserves. Notwithstanding this belief, it must be remembered that these institutions, with their pecuniary endeavors, are the backbone of the robust small business environment that has been created in Florida. Without their funding, Florida would not have accounted for almost 12% of all new business start-ups nationwide between January 2021 and January 2022.[x] In order to continue serving its economy and provide opportunity to its citizens, Florida should aim to protect business creditors to true small businesses by either implementing slight restrictions on the formation of limited liability entities, reevaluating its veil-piercing standards, or a combination of both. In doing so, Florida would encourage creditors to continue funding the entrepreneurial nirvana that the state currently houses while reducing the likelihood of payment failures.
[i] See What Does Piercing the Corporate Veil Mean for My Company?, Miller L. Insights, https://millerlawpc.com/what-does-piercing-the-corporate-veil-mean-for-my-company (Jan. 19, 2021).
[ii] See GreenHunter Energy, Inc v. W. Ecosystems Tech, Inc., 2014 WY 144, 337 P.3d 454 (2014).
[iii] See Dania Jai-Alai Palace, Inc. v. Sykes, 450 So. 2d 1114 (Fla. 1984).
[iv] Fla. Div. Corp., https://dos.fl.gov/sunbiz/about-us/yearly-statistics/ (last visited Nov. 18, 2024).
[v] U.S. Small Bus. Admin., 2023 Small Business Profile: Florida (2023), https://advocacy.sba.gov/small-business-data-resources/.
[vi] Id.
[vii] See Erica Taylor, Legal Literacy: Why it Matters for Small Business Owners, Legally Literate, https://legalliteracyfoundation.com/legal-literacy-why-it-matters-for-small-business-owners/ (Aug. 1, 2024) (“The reality for most small business owners is their legal literacy is limited to one, maybe two subjects they have done as part of their tertiary or vocational education.”).
[viii] Sykes, 450 So. 2d at 1117.
[ix] See Small Business Statistic, Chamber of Commerce, https://www.chamberofcommerce.org/small-business-statistics/ (last updated July 24, 2024) (discussing information collected by the Bureau of Labour Statistic).
[x] See Ron Starner, How Florida Became a Launchpad for Small Business Growth, Site Selection Mag.,https://siteselection.com/issues/2022/may/how-florida-became-a-launchpad-for-small-business-growth.cfm (May 2022).
