A divided division of the Colorado Court of Appeals has held, in Martin v. Freeman and Tradewinds Group, LLC, 2011 CA 145 (Colo. App. Feb. 2, 2012),  that “wrongful intent or bad faith need not be shown” to pierce the corporate veil to reach the personal assets of a member of a limited liability company.

The decision represents a departure from established case law in Colorado, which historically has disregarded corporate formalities only in rare circumstances where wrongful conduct threatens to result in manifest injustice.  The mere fact that a creditor might not be paid, standing alone, has never before been considered enough reason to pierce the corporate veil in Colorado.  It remains to be seen whether other divisions of the Colorado Court of Appeals will apply the liberalized standard adopted in this case.  Whether they do so or not, this issue may not ultimately be resolved until it is finally addressed one day by the Colorado Supreme Court.

In this case Freeman managed Tradewinds as an out-of-state, single member limited liability company (LLC).  In 2006, Tradewinds successfully sued Martin for the alleged breach of a construction agreement to build an airplane hangar.  Martin appealed, and in 2009, the judgment was reversed.  On remand, the trial court entered judgment in favor of Martin and awarded him $36,645.40 in costs. 

In 2007, while the lawsuit was pending, Tradewinds sold its only meaningful asset, an airplane.  Freeman took the proceeds of the sale as a distribution, which he deposited in his personal account.

By the time that the cost award was assessed against Tradewinds in 2009, the company had no assets and therefore, was unable to pay Martin.  In 2010, Martin initiated an action against Freeman to pierce the corporate veil.  Following a bench trial, the trial court pierced the corporate veil and found Freeman personally liable.

The judgment was affirmed on appeal.  The Colorado Court of Appeals followed established Colorado case law in recognizing that to pierce the corporate veil, a court must conclude (1) the corporate entity is an alter ego or mere instrumentality; (2) the corporate form was used to perpetrate a fraud or defeat a rightful claim; and (3) an inequitable result would be achieved by disregarding the corporate form. 

Freeman argued that the trial court had erred in finding that the second prong was satisfied because it did not find any wrongful intent or bad faith.  A majority of the court of appeals disagreed, holding that it was sufficient to establish that the corporate form had been used to defeat a creditor’s rightful claim.  It held that Freeman, by selling the airplane, had “drained Tradewinds of all assets during the litigation, even though it was exposed to potential liability because it had sued Martin.”  It particularly relied on the finding by the trial court that Tradewinds had violated a Colorado statute that prohibits limited liability companies from making distributions to members, if the effect of the distribution is to leave the company with liabilities in excess of its assets.

In a sharply worded dissent, Judge Jerry Jones wrote that insulation from individual liability “is an inherent purpose of incorporation.”  An individual sought to be held liable “must have misused the corporate form in a manner that, if not criminal, was at least unlawful or intended to defeat a claim.”  “Any lower standard,” he continued, “would fail to give meaningful content” to prior decisions by the Colorado Supreme Court, which had given “consistent references to ‘wrongful’ conduct.”  It would, he concluded, “make veil piercing less than the ‘extraordinary’ remedy it has always been intended to be.” 

Judge Jones pointed to the trial court’s findings that at the time of the sale of the airplane in 2007, fully two years before costs were assessed against Tradewinds, “all of the known or reasonably possible debts of the entity were fully provided for.”  The trial court further found that Freeman “actually and reasonably believed” at the time of the sale that Tradewinds “had more than sufficient value to cover any reasonably possible obligation on the horizon.”  Judge Jones concluded these findings did not justify piercing the corporate veil to hold Freeman personally liable for unforeseen corporate debts arising long after the sale of assets had occurred.