With good fortune this unpublished opinion by the Colorado Court of Appeals will be reversed on appeal. Until then, lawyers need to take notice of this case because it is indicative of the risk inherent in operating a single member LLC. Call it limited liability light, but some courts seem to give less deference to the limited liability protections of LLCs compared to corporations.
Dean Freeman owned and managed Tradewinds Group, LLC as a single member LLC. Tradewinds contracted with Robert Martin to build an airplane hangar. Now, follow the dates. In 2006 Tradewinds sues Martin for breach of contract. In 2007 Tradewinds sold its only “meaningful” asset, an airplane, for $300,000 (the court apparently didn’t think the claim against Martin was meaningful). The proceeds of the sale went directly to Freeman, the only member of the LLC. In 2008 a judgment was entered in favor of Tradewinds. In 2009 this judgment was reversed, Martin was declared the winner and awarded costs of $36,645.40. In 2010, following a bench trial, the trial court pierced the limited liability veil and found Freeman personally liable.
The court of appeals decision was split 2-1. The majority apparently didn’t find it significant that Tradewinds sold its only significant tangible asset one year before judgment was entered in its favor against Martin, two years before the judgment was reversed, and three years before the bench trial that led to the eventual piercing of the veil. See Martin v. Freeman, 2012 WL 311660 (Colo. App. 2/2/12).
Instead, the court relied on (1) Tradewinds assets were commingled with Freeman’s and another of his companies, Aircraft Storage LLC (it is not explained how one commingles an aircraft with other assets); (2) the LLC had negligible corporate records (Colorado law declares that the failure of an LLC to observe formalities and requirements is not in itself grounds to impose personal liability); (3) Tradewinds had inadequate records of its substantive transactions; (4) a single person was the LLC’s only member and manager (!?); (5) the entity was thinly capitalized (with an airplane!); (6) cash infusions to pay bills were undocumented; (7) Tradewinds never operated as an active business (never seen this one before); (8) legal formalities were ignored (see above); (9) Freeman paid the LLCs debts without characterizing the transactions; (10) the airplane was used for “nonentity purposes”; and (11) Tradewinds was operated as “a mere assetless shell” and the proceeds from the sale of this assetless shell’s asset went directly to its only member.
The majority overlooks, but the dissent reminds them, that the trial court found the plane was sold in an arm’s length transaction, the proceeds were a lawful distribution to Freeman under Colorado law, he was unaware of any impropriety with respect to the sale, and to his knowledge all debts of the entity were provided for at the time of the distribution.
The court also found that showing that the LLC form was used to defeat a creditor’s rightful claim is all that needs to be shown and “further proof of wrongful intent or bad faith is not required.”
The dissenting judge came to an opposite conclusion, finding that the sale of the airplane and distribution of the proceeds two years before Martin had a claim against Freeman could not be construed to be a use of the LLC form to defeat a creditor’s rightful claim. The dissent cites a host of cases involving corporations where attempts to pierce the veil were thwarted because no wrongful conduct was proven.
As the dissent reasonable explains, two years before Martin had a claim against the LLC, Tradewinds sold its primary asset, “it made sense that the business would be closed…and its funds taken by its sole member.”
What this case says to SMLLCs is simple. You need to document your transactions, keep your funds separate and mind your p’s and q’s to a much greater extent than if you were a corporation. I wish this wasn’t the case, but this opinion and a host of others suggest to me that some courts have yet to grasp the fact that LLCs and corporations should be treated the same when it comes to limited liability protections.