Piercing the Veil of a Single-Member LLC
Updated: Sep 6, 2020
The vast majority of small business owners will form a limited liability company (LLC) to protect their personal assets from liability for the debts and actions of their company. Where there is only one owner, this entity is a "single-member" LLCs - it can provide powerful protections but is also the most vulnerable to a claimant seeking to pierce the corporate veil. This is particularly true where the owner of a single-member LLC fails to take every step to properly maintain the distinctness of the LLC.
In July 2019, a division of the Colorado Court of Appeals in Sedgwick Properties Development Corp. v. Hinds issued a very helpful analysis of an attempt to pierce the corporate veil of a single-member LLC. Id., 456 P.3d 64 (Colo. App. 2019). There, the court analyzed the eight factors used in Colorado to determine if an entity is the alter ego of its owner. Sedgwick provided several interesting insights into alter ego law, but relevant here the court took a deep dive into considering the weight that should be given to each of these eight factors in the case of a single-member LLC. Sedgwick found that many of these elements should be afforded no weight, because even if they are met "they are also consistent with [the entity's] operation as a single-member LLC." Id. at 71.
Factor 1: Distinct Business Entity: The court noted that status as a 'disregarded entity,' or that an entity doesn't file a separate tax return "does not affect its status as a distinct entity organized and existing under [Colorado statute]." Id. at 73.
Factor 2: Funds and Assets are Commingled: The only evidence in Sedgwick of commingling of assets was that a joint settlement of a separate lawsuit was paid by one entity, but that the settlement benefited both entities. The court rejected that analysis and said that this is a common scenario, therefore it doesn't provide any support for an alter ego finding. While I disagree with that analysis, that was the court's holding. Id. at 72.
Factor 3: Adequate Corporate Records are Maintained: The court didn't address this factor specifically (though it's arguably blended in to Factor 7, below).
Factor 4: Structure Facilitates Misuse by an Insider: The court essentially blew off this element, stating that even though the trial court found this factor supported an alter ego finding because all entities were controlled by the same person, "those circumstances do nothing to establish [one entity] as an alter ego of [the other entity]." Id. at 73.
Factor 5: The Business is Thinly Capitalized: The Court of Appeals found this to be the only factor that supported piercing the corporate veil, but still largely dismissed the trial court's reliance on this factor. The court said that because the business initially raised over $1 million, and "paid off more than $30 million in loans," it was not undercapitalized. Id. at 74. Here, the trial court relied most heavily on the fact that the pierced entity did not have the funds to pay the judgment in question, but again dismissed this as insufficient because the purpose of the pierced entity (to develop the property in question) had been fulfilled upon completion of the project, and therefore the fact that it was now without funds did not justify piercing the veil. Id.
Factor 6: The Entity is a "Mere Shell": The Court of Appeals agreed, without further discussion, with the trial court's finding that the pierced entity was not a "mere shell" for the target entity.
Factor 7: Legal Formalities are Disregarded: The trial court, in piercing the veil, found it significant that the pierced LLC had "no board of directors," and "there were no . . . minutes of any meetings of any board of directors." Here is perhaps the most significant example of where the Court of Appeals deviated from standard practice with regards to corporations and stated that it is not common--and should not be punished--for a single-member LLC to not have a board of directors or hold regular meetings. Unlike Colorado's Corporation Act, the LLC Act does not require annual meetings of shareholders or board members. Indeed, what is the purpose of a meeting with oneself? The Court of Appeals did state, however, that where a single-member LLC does go to the trouble of papering up these formalities, that could serve to bolster its defense against veil piercing. Id. 73.
Factor 8: Corporate Funds used for Noncorporate Purposes: the court blended its analysis here with that for Factor 2, above.
The court in Sedgwick stated that trial courts "must tread carefully and must consider whether traditionally applied veil-piercing factors are applicable in the context of a [single-member LLC]." Id. at 71. Accordingly, the court found that the analysis above did not support the piercing of the corporate veil, and reversed the trial court.
Sedgwick shows the kind of detailed analysis a court should undertake before piercing the corporate (or, as here, LLC) veil, and exactly what elements need to be argued for an effective prosecution or defense of these claims. In my experience, the biggest missing piece of the analysis here was the lack of any examination of the two entities' accounting records. Keeping complete - and separate - books, maintaining separate bank accounts, as well as more trivial things like different website URLs, different phone numbers, and different email addresses, can be essential to defending against veil piercing.
Jeff Vail is the founder of Vail Law LLC in Greenwood Village, Colorado. He has extensive experience representing plaintiffs and defendants in all types of business litigation, including alter ego and veil-piercing claims, breach of fiduciary duty claims, breach of contract claims, fraud and fraudulent concealment claims, and fraudulent transfer claims. Contact us at (303) 600-3730 or firstname.lastname@example.org.