Horizontal and Reverse Piercing the LLC Veil
Updated: Sep 5, 2020
One of the primary benefits of a limited liability company (LLC) is that it protects its owner’s personal assets. By law, an LLC is a separate legal entity from the members who own it, and, generally, neither the members nor managers of an LLC are personally liable for its debts. C.R.S. § 7-80-705 (2019). That corporate veil, however, can be pierced under certain circumstances—meaning the LLC’s owner can be held personally liable for a debt or claim against the LLC. See, e.g., In re Phillips, 139 P.3d 639 (Colo. 2006). Often, this alter ego claim is the most crucial element in business litigation.
While most attorneys and LLC owners are aware of the general concept of piercing the corporate veil, they may not understand the important differences separating standard veil piercing and reverse veil piercing under Colorado law. Now, in April of this year in Dill v. Rembrandt Group, Inc., Colorado appellate courts not only clarified the law of reverse piercing, but also for the first time expressly accepted and defined the requirements for the complementary concept of “horizontal veil piercing.” Id., 2020 C.O.A 69. These developments are critically important for both the owners of LLCs and closely-held corporations, as well as those who may have claims against them.
Piercing vs. Reverse Piercing
If an LLC “is merely an instrumentality for the transaction of the shareholder’s or member’s affairs,” and “there is such unity of interest in ownership that the separate personalities of the corporation [or LLC] and the owner no longer exists,” then a court may find that the LLC and its owner are alter egos of each other. Phillips, 139 P.3d at 643-44. This alter ego status does not mean there has been wrongdoing. However, if an individual and an LLC are found to be alter egos of each other, and the LLC form was used to defraud or defeat liability for a debt or claim, then a court will pierce the veil of that LLC to achieve an equitable result. Id. at 644.
If the original claim is against the LLC, and the creditor or injured party is attempting to hold the individual owner of the LLC liable (and collect against that individual’s assets), this constitutes a standard veil-piercing claim. However, if the claim is against the individual, and the injured party is attempting to hold the LLC liable and collect from its assets, this constitutes a reverse veil-piercing claim.
The Logical Next Step: Horizontal Piercing
Given the creativity and effort put into corporate structures and asset protection plans (or schemes—depending on one’s point of view), it is not uncommon to find a veritable set of Russian nesting doll entities designed to safeguard assets against collection. In Dill, the Colorado Court of Appeals endorsed at least the potential to defeat even complex asset protection schemes (or, alternatively, to draw earnestly separate corporate entities into shared liability).
To simplify the facts in Dill, the assets under attack belonged to the defendant’s sister entity—which shared parent companies, but was not otherwise owned by defendant. This would have required piercing the corporate veil directly from subsidiary to parent owners, and then reverse-piercing from these parent owners to a separate subsidiary entity—collectively representing a “horizontal” pierce between sister-entities with no direct ownership in each other.
The court in Dill approved this concept of horizontal piercing but reversed the judgment after finding the trial court had not made each specific alter ego finding required to support every component piercing step along the way. In theory, this ruling highlights the potential to pierce virtually any structure or scheme, or to link any individuals and entities in common liability. But in application, by reversing the trial court’s judgment without contemplating any equitable leap to overcome missing factual findings, Dill also highlights the challenge of actually piercing a complex corporate structure. These issues were not implicated in Dill (and the Colorado Supreme Court has yet to weigh in). But the key question going forward will be whether a clear finding of fraudulent intent is sufficient for a court to skip over some otherwise-required alter ego findings for horizontal piercing. This will be especially important with opaque or intentionally-disguised corporate structures or offshore asset protection trusts.
Every veil-piercing scenario is complex and fact-specific. Vail Law is uniquely experienced in this area of law—please contact us directly to discuss your legal needs.
Jeff Vail is the founder of Vail Law LLC in Greenwood Village, Colorado. He has extensive experience representing plaintiffs and defendants in trials and arbitration involving alter ego and veil-piercing claims, including successfully piercing the corporate veil in multiple Colorado trials - see articles HERE, HERE, and HERE on past alter ego victories. Vail Law also advises clients on protecting against alter ego risks.