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.