A question often asked is whether or not a single member LLC (SMLLC) will protect the owner from personal liability should something go wrong and the company is sued. In other words, can a Colorado plaintiff easily pierce the corporate veil and go after the personal assets of the business owner? Commonly, known as “piercing the corporate veil“. The answer of course is, it depends.
Since Colorado allows LLCs to have only one member. C.R.S. 7-80-204(g) and can be for any lawful purpose, C.R.S. 7-80-103 by default the company is a separate legal entity from their owner. Because of this separateness, the owner of the business does not share liability with the company. Sometimes however, a court will decide the SMLLC isn’t truly a separate entity from the owner and hold the sole owner of the business legally responsible. A plaintiff has to jump a few hoops for this to happen. And, it’s not as easy as you think.
Colorado’s corporate veil statute
Colorado Revised Statute 7-80-107 titled “Application of Corporation Case Law to Set Aside Limited Liability” states the following:
(1) … the court shall apply the case law which interprets the conditions and circumstances under which the corporate veil of a corporation may be pierced.
(2) …the failure of a limited liability company to observe the formalities or requirements relating to the management of its business and affairs is not in itself a ground for imposing personal liability on the members…
(3) A limited liability company’s status for federal tax purposes does not affect its status as a distinct entity organized and existing under this article.
To summarize, the courts apply case law to determine whether the member of a single-member LLC is liable; it’s not absolutely necessary for a SMLLC to adhere to all corporate formalities; the LLC is still viewed as a separate entity under Colorado law regardless of tax status. Therefore, you and your business have the same rights regardless if you file a schedule schedule C (self-employed) or a schedule S (S-Corporation).
Three part test under Colorado case law
Liability laws specifically for single-member LLCs are relatively new, and are still an evolving area of the law. A 2019 Colorado court of appeals case helps clarify personal liability and single member LLCs.
Here’s a link to the the court of appeals decision, Sedgwick Props. Dev. Corp. v. Hinds, 456 P.3d 64 (Colo. App. 2019) For those of you don’t care to read through it, here’s what it says regarding piercing the corporate veil for a single-member LLC.
Deciding in favor of the single-member LLC, the court of appeals used a three part test to determine whether the manager should be held personally liable and allow the piercing of the business’s veil.
- the court must determine whether the LLC is a mere alter ego of the member.
- it determines whether the business is used to commit fraud or defeat a rightful claim.
- the court considers whether it’s equitable and fair to the business owner.
A plaintiff has to clear all three hurdles to prevail.
The person suing you must show a few things for them to successfully go after your personal assets. The plaintiff must show the SMLLC is not really a separate entity from its sole member. The term for a business owner acting one and the same is the alter ego doctrine.
Courts examine these factors to determine whether or not the alter ego doctrine applies:
- did the LLC operate as a distinct business entity;
- did the member and LLC commingle funds and assets;
- did the owner and LLC maintain adequate business records;
- did the ownership and control of the LLC facilitate misuse by an insider;
- did the LLC act a ‘mere shell’;
- was the LLC thinly capitalized;
- were legal formalities disregarded; and
- were corporate funds or assets used for non-corporate purposes.
A court will look at the specific facts of the case. They don’t need to find the existence of every factor to find an alter ego.
Fraud or Deceit
If the court does find the business is an alter ego of the owner, then it must determine if the company is committing fraud or cheating a rightful owner of property. Simply, is the owner using the company to lie to, or harm someone. Since an LLC can exist for any legal purpose; all you have to do is be an honest, legit business person and the plaintiff will fail. Sometimes people get in to trouble with this element, when they transact a lot of business in cash. They pocket the money instead of declaring it as income, thereby deceiving to the government.
If the business is an alter ego of the owner; and it’s committing fraud or harm. The person suing the business owner must also show, going after personal assets is fair to the owner. An instance when it would be unfair to the owner; is if the owner operates the business legitimately and honestly, doesn’t commingle funds, and follows business formalities. Court’s will allow piercing the corporate veil if it’s fundamentally unfair to the owner or an investor. This final hurdle is the easiest for the plaintiff to overcome. Since by this time, if they’ve overcome the first two hurdles, more than likely the business and it’s owner did not conduct the business as they should have.
A couple things to note about the decision in the Sedgwick case;
- since corporations are quite different from single member LLCs; and since corporate rules aren’t easily transferred or don’t easily apply to SMLLCs, an LLC is not corporation. It’s an LLC.
- the single member LLC involved in the lawsuit was manager-managed by someone who was not the owner. Therefore, Colorado courts have yet to decide on this issue regarding an LLC that is member-managed or is manager-managed by the owner.
Even though piercing the corporate veil isn’t an easy task for a someone who’s suing you. Don’t make it easy for them. As a rule, Keep your business and personal assets separate. Also, get an operating agreement if don’t have one already. Know what the document says and what you’re supposed to do. In addition, maintain business formalities as they apply to your LLC. Run an honest and legitimate business. Lastly, get professional help if you need it.Follow me on social media: