Colorado Court of Appeals Rules on Piercing Corporate Veil

In a newly published decision, McCallum Family LLC v. Winger, Case No. 09CA0212 (Colo. App. Oct. 29, 2009), the Colorado Court of Appeals ruled on several interesting issues related to "piercing the corporate veil." In general, a corporation or other legal entity is treated as a legal "person" or entity separate and apart from its owners and managers. This rule protects owners and managers of an entity from personal liability for the entity's debts. This protection or "veil," however, may be pierced in extraordinary circumstances, and under those circumstances, owners and managers of an entity may be held liable for liabilities of the entity.

There is a three part test under Colorado law to determine whether it is appropriate to pierce the corporate veil. First, the court determines whether the "corporate entity is the 'alter ego' of the person or entity in issue." Second, the court determines whether the use of the entity form was "used to perpetrate a fraud or defeat a rightful claim." Finally, the court considers "whether an equitable result will be achieved by disregarding the [entity] form and holding a shareholder or other insider personally liable for the acts of the business entity."

Courts consider a number of factors in determining whether an entity is an alter ego of an owner or manager, including, without limitation, commingling of funds and assets, inadequate corporate records, thin capitalization, and disregard for legal formalities.

In Winger, the Court applied the alter ego test to Marc Winger even though he had no formal ownership in the entity and held no formal office in the entity, like officer or director. The evidence showed that Marc Winger essentially functioned as an owner of the entity and was the primary manager of its business. The Court held that "an individual who acts as a de facto shareholder, officer, or director may be treated as an equitable owner and held to be the alter ego of a corporation."

The second prong of the veil-piercing test requires a showing that the entity was "used to perpetrate a fraud or defeat a rightful claim." The Court further defined this rule by stating that the conduct does not need to be directed at the plaintiff-creditor, but rather "the creditor seeking to pierce the veil must show an effect on its lawful rigths as a creditor resulting from abuse of the corporate form." In Winger, the requisite effect was established through evidence that the defendants removed all funds from the corporation, leaving no funds to satisfy the debt owed to the plaintiff.

With respect to the final prong of the veil-piercing test, the court must determine whether an equitable result will be achieved by piercing the corporate veil and holding the owner or manager in question liable for the acts of the entity. As to this determination, the Court deferred to the trial court's discretion.

Another interesting issue raised in Winger was whether officers of a corporation owe fiduciary duties to creditors when the corporation is insolvent. Colorado cases have held that officers and directors of insolvent corporations do owe fiduciary duties to creditors. The Court questioned whether this common law rule was overturned by the amendment of C.R.S. 7-108-401(5) in 2006, which section provides that a "director or officer of a corporation, in the performance of duties in that capacity, shall not have any fiduciary duty to any creditor of the corporation arising only from the status as a creditor." The Court did not decide on this issue, but perhaps raised it for future consideration by the General Assembly or the Supreme Court.

Posted By: Brent W. Houston, Esq.

Colorado Supreme Court Rules on Adverse Possession of Parking Space

The Colorado Supreme Court recently ruled that an entity claiming title to a parking space in a condominium community by adverse possession under color of title could not sell the space free from the transfer restrictions in the condominium declaration. B.B. & C. Partnership, v. The Edelweiss Condominium Assoc'n, Case no. 08SC394 (Colo. S.Ct., October 13, 2009).

This case involved a parking space located in the Edelweiss Condominiums in Vail, referred to as "parking space 21." In 1976, BB&C purported to purchase parking space 21 from a former owner of a condominium unit, receiving a warranty deed to the space which provided, in pertinent part, that the conveyance was "subject to the terms, covenants, conditions, easements, restrictions, uses, limitations and obligations set forth in [the]Declaration" governing the condominium. The condo declaration restricted sale of parking spaces to other condo owners. BB&C was not a condo owner.

After obtaining the deed for parking space 21, an employee of BB&C parked his car in the space for a period of more than 20 years, during which time BB&C paid all taxes, maintenance fees, and insurances fees. In 2003, BB&C attempted to sell parking space 21 to a third-party non-condominium owner, but the condo association blocked BB&C's access to the space -- access being through a locked gate. BB&C filed a quiet title action claiming unrestricted fee simple ownership of parking space 21 by adverse possession under color of title pursuant to C.R.S. sec. 38-41-108.

C.R.S. 38-41-108 provides that person who is in possession of land for seven successive years, under color of title, made in good faith, and during that time pays taxes assessed on the land shall be adjudged the owner of the land "to the extent and according to the purport of his paper title." "Color of title" means title evidenced by a written document purporting to convey title to real property, but which fails to do so because of some defect.

The Supreme Court ruled that BB&C could obtain a quiet title judgment recognizing its ownership of parking space 21 if it proves its claim at the trial court level, but it is not entitled to a judgment for unrestricted fee simple ownership, title would be subject to the transfer restrictions in the condo declaration. It reasoned that parking space 21 was a limited common element of the condominium community subject to the restrictions contained in the condo declaration, and therefore the person from whom BB&C purported to purchase the space did not have unrestricted title, rather such title was subject to the condo declaration restrictions. Also, the "paper title" received by BB&C specifically provided that it was subject to the condo declaration. As a result, if BB&C successfully proves its quiet title claim, then its title will likewise be subject to the transfer restrictions contained in the condo declaration, effectively limiting the units sale to other condo owners.

Posted By: Brent W. Houston, Esq.

Englewood Sign Code Regulating Wall Murals Held Unconstitutional

The Colorado Court of Appeals recently held that the City of Englewood's sign code regulating wall murals was an unconstitutional prior restrain on protected free speech. Mahoney v. City of Englewood, Case No. 08CA1505 (Colo. App, Oct. 1, 2009). Prior restraint in this context means regulation of protected speech prior to the time such speech is to occur.

The case involved murals painted on a building located in Englewood's "South Broadway Sign Area." In that area, murals are permitted under Englewood's sign code, but are subject to prior approval by the city manager. See, EMC sec. 16-6-13.K. The approval process is where the Court of Appeals found fault.

Englewood's sign code had no specific approval period for the city manager's final decision on an application for a mural permit. The Court of Appeals concluded that the lack of a definite time period created a risk of indefinitely suppressing permissible speech. It then held that, to pass constitution scrutiny, the "review procedure must require the city manager to decide whether to issue a permit within a brief, specified time period ... and there must be the possibility of prompt judicial review in the event the permit is erroneously denied."

Posted By: Brent W. Houston, Esq.