- Jeff Vail vail-law.com
The Alter Ego Factors: How Courts Decide if Limited Liability Survives
Updated: Sep 5, 2020
This is part of Vail Law's Litigation Checklist. Connect with me on LinkedIn.
A limited liability company (LLC) is a separate legal entity from both its managers and its shareholders. In re Phillips, 139 P.3d 639, 643 (Colo. 2006). This fiction of the LLC separates the shareholders and managers from the LLC’s "actions, profits, and debts." Id. But it is possible (and, indeed, commonplace) to pierce that corporate veil and hold either shareholders or managers directly responsible for the actions and debts of the LLC. It is also possible to pierce this veil in reverse (hold LLC and its assets liable for acts and debts of shareholder) and to pierce the veil horizontally (hold sister entities liable despite no direct ownership).
To pierce the veil under Colorado law there is a three-part test: (1) is the LLC the alter ego of the shareholders or managers; (2) does justice require piercing the veil; and (3) does actually doing so lead to an equitable result? McCallum Family LLC v. Winger, 221 P.3d 69, 74 (Colo. App. 2009).
Determining that first question—is the entity the alter ego of the shareholder or manager—is resolved in Colorado by considering eight factors, which were first specified by the Colorado Supreme Court in Leonard v. McMorris, 63 P.3d 323, 330 (Colo. 2003), but originating from the Tenth Circuit’s statement of alter ego eight factors under “federal common law.” U.S. v. Van Diviner, 822 F.2d 960, 965 (10th Cir. 1987) (collecting cases from other circuits and Wyoming state law from 1982-1985). It is important to note that when Van Diviner was published, only Wyoming and Florida had the LLC form, and its tax treatment was not approved by the IRS—as a result, the factors cited in Van Diviner, which now apply to LLCs, were based entirely on the common law with respect to corporations.
Colorado’s eight factors are:
the corporation is operated as a distinct business entity;
funds and assets are commingled;
adequate corporate records are maintained;
the nature and form of the entity's ownership and control facilitate misuse by an insider;
the business is thinly capitalized;
the corporation is used as a "mere shell";
legal formalities are disregarded; and
corporate funds or assets are used for noncorporate purposes.
Phillips, 139 P.3d at 644.
Other states use similar factors. See, e.g., Eskelsen v. Theta Inv. Co., 437 P.3d 1274, 1283 (Utah. App. 2019) (Utah’s seven factors for its “formalities requirement,” with focus on actions of dominant shareholders); Ridgerunner, LLC v. Meisinger, 297 P.3d 110, 115 (Wyo. 2013) (listing factors); Keg Restaurants Arizona, Inc. v. Jones, 375 P.3d 1173, 1182-83 (Ariz. App. 2016) (listing factors in parent-subsidiary alter ego question, focusing on degree of control); N.R.S. 78.747 (Nevada statute codifying the alter ego test in that state); Morrison Knudsen Corp. v. Hancock, 69 Cal.App.4th 223, 249-250 (1999) (California factors); U.S. Bank, N.A. v. U.S. Timberlands Klamath Falls, L.L.C., Del. Ch. Mar. 30, 2005 (Delaware Factors).
Every case is unique, and it is essential to understand the facts and law in your case—ideally before a case exists. Vail Law has had unique success in alter ego law representing both plaintiffs and defendants, and providing proactive, preventive advice to avoid litigation entirely. I will be publishing case studies of several of our alter ego victories here, including: (1) successful use of alter ego doctrine to hold multiple Quizno’s corporate parent companies liable for actions of franchisee after bench trial; (2) successful piercing of an LLC dentist office to obtain judgment against owner; (3) successful piercing the veil on behalf of angel investor-backed start-up to obtain judgment against founders personally. View our entire Litigation Checklist.