Piercing the Corporate Veil: Corporations and LLC’s
By: Anthony Vanicek
In general members of an LLC and shareholders of Corporations cannot be held liable for debts of the company or even judgments against the company. However, in specific limited circumstances a court will disregard the corporate or LLC form and hold the individual members liable. Therefore, managers and members of LLC’s and corporations should take great care to avoid the risk that any members or shareholders could be held personally liable for the debts of the business entity.
There are generally three situations where the corporate veil will be pierced. The first is the “alter ego” theory. When a corporation ignores corporate formalities such that the corporation is the mere “alter ego” of the shareholders or members (or of another corporation), the corporate veil may be pierced. Courts examine whether there is such a “unity of interest in ownership” that the “separate personalities” of the corporation and the shareholder no longer exist. A company is said to be “ignoring corporate formalities” when shareholders or members treat corporate assets as their own, intermingle personal finances with business finances, and when an injustice would result from recognizing the corporate form and shielding shareholders from liability.
Another situation where a court might pierce the corporate veil is one where a company appears to be deliberately undercapitalized in order to avoid liability. Courts have not put a dollar amount figure on what constitutes undercapitalization. Courts will look to the amount of capital (typically at the time of formation) and analyze whether that is an appropriate amount of capital in light of a company’s reasonably anticipated expenses and liabilities.
The last situation where a court might pierce the corporate veil is one where a company is deliberately trying to avoid existing obligations, commit a fraud, or evade statutory obligations. This often occurs when a company creates a shell subsidiary to conduct risky business (often combined with undercapitalization). If the subsidiary was created for the sole purpose of shielding the parent company from liability from risky conduct, a court may pierce the corporate veil.
However, piercing the corporate veil is considered a drastic remedy, and courts will typically honor the protections of the corporate form. The court must consider whether disregarding the corporate form and holding the shareholder personally liable for the corporation’s acts will lead to an equitable result.” The Colorado Business Corporation Act (CBCA) and the Colorado Limited Liability Company Act (LLC Act) specifically protect equity owners from liability.
Under C.R.S. § 7-80-705 (applicable to LLC’s) members and managers of limited liability companies are not liable under a judgment, decree, or order of a court, or in any other manner, for a debt, obligation, or liability of the limited liability company. (some exceptions can be found in C.R.S. § 7-80-107(1) and C.R.S. § 7-80-606(2)). Additionally, C.R.S. § 7-80-107(2) specifically provides that “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 for liabilities of the limited liability company.”
Under C.R.S. § 7-106-203, (applicable to corporations) “(1) A purchaser from a corporation of shares issued by the corporation is not liable to the corporation or its creditors with respect to the shares except to pay the consideration for which the shares were authorized to be issued . . .” Additionally, “a shareholder or a subscriber for shares of a corporation is not personally liable for the acts or debts of the corporation; except that such person may become personally liable by reason of the person’s own acts or conduct.”