Martin v. Freeman

• Decision Date: 02 February 2012
• Docket Number: No. 11CA0145.,11CA0145.
• Citation: 2012 COA 21,272 P.3d 1182
• Parties: Robert L. MARTIN, Plaintiff–Appellee, v. Dean C.B. FREEMAN; and Tradewinds Group, LLC, a Delaware limited liability company, Defendants–Appellants.
• Court: Colorado Court of Appeals

2012 COA 21

272 P.3d 1182

Robert L. MARTIN, Plaintiff–Appellee,

v.Dean C.B. FREEMAN; and Tradewinds Group, LLC, a Delaware limited liability company, Defendants–Appellants.

No. 11CA0145.

Colorado Court of Appeals, Div. VII.

Feb. 2, 2012.

Mulliken Weiner Karsh Berg & Jolivet, P.C., Murray I. Weiner, Colorado Springs, Colorado, for Plaintiff–Appellee.

Rothgerber Johnson & Lyons LLP, Michael Francisco, Colorado Springs, Colorado, for Defendants–Appellants.

Opinion by Judge NEY.^*

¶ 1 In this limited liability company (LLC) veil-piercing case, defendants, Dean C.B. Freeman and Tradewinds Group, LLC, appeal the trial court's judgment in favor of plaintiff, Robert C. Martin. We affirm.

I. Factual Background

¶ 2 Freeman managed Tradewinds as a single member LLC. Tradewinds contracted to have Martin construct an airplane hangar. In 2006, Tradewinds sued Martin for breaching the construction agreement. In 2007, while the litigation against Martin was pending, Tradewinds sold its only meaningful asset, an airplane, for $300,000, and the proceeds of that sale were diverted to Freeman, who paid Tradewinds' litigation expenses. In 2008, a judgment was entered in favor of Tradewinds. Martin appealed. Another division of this court concluded that Tradewinds' damages were speculative and remanded with directions to enter judgment in Martin's favor. Tradewinds Group, L.L.C. v. Martin, (Colo.App. No. 08CA1300, 2009 WL 1629960, June 11, 2009) (not published pursuant to C.A.R. 35(f)). On remand, the trial court declared Martin the prevailing party and awarded him $36,645.40 in costs.

¶ 3 Because the proceeds of the sale of Tradewinds' only significant asset, the airplane, went directly to Freeman, the LLC was without any assets. Martin initiated this action to pierce the LLC veil. Following a bench trial in 2010, the trial court pierced the LLC veil and found Freeman personally liable for the cost award entered against Tradewinds. Defendants appeal.

II. Veil Piercing

¶ 4 Defendants contend that the court erred in piercing the LLC veil. We disagree.

¶ 5 The piercing of an LLC veil is a mixed legal and factual question. See McCallum Family L.L.C. v. Winger, 221 P.3d 69, 73 (Colo.App.2009) (standard of review for piercing corporate veil); see also Sheffield Services Co. v. Trowbridge, 211 P.3d 714, 721 (Colo.App.2009) (veil piercing applies to limited liability companies). Defendants have not designated the trial transcripts and do not dispute the court's factual findings. We therefore accept the court's factual findings and review de novo its application of the law to those facts. See McCallum Family L.L.C., 221 P.3d at 73.

¶ 6 To pierce the LLC veil, the 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 equitable result would be achieved by disregarding the corporate form. Id. at 74. The third prong, in particular, recognizes that veil piercing is a “fact-specific” inquiry. See id. at 79; see also Micciche v. Billings, 727 P.2d 367, 373 (Colo.1986) (in the absence of a fully developed factual record and adequate factual findings, appellate court could not determine whether to disregard the corporate form).

¶ 7 Defendants contend that the court's factual findings do not support piercing the LLC veil. Specifically, they challenge the court's conclusions that the first and second prongs were satisfied. We address each prong in turn.

A. Alter Ego

¶ 8 Defendants contend that the court erred in finding that Tradewinds was Freeman's alter ego. We disagree.

¶ 9 Courts consider a variety of factors in determining alter ego status, including whether (1) the entity is operated as a distinct business entity; (2) funds and assets are commingled; (3) adequate corporate records are maintained; (4) the nature and form of the entity's ownership and control facilitate insider misuse; (5) the business is thinly capitalized; (6) the entity is used as a mere shell; (7) legal formalities are disregarded; and (8) entity funds or assets are used for non-entity purposes. McCallum Family L.L.C., 221 P.3d at 74.

¶ 10 In concluding that Tradewinds was Freeman's alter ego, the court found:

• Tradewinds' assets were commingled with Freeman's personal assets and the assets of one of his other entities, Aircraft Storage LLC;

• Tradewinds maintained negligible corporate records;

• the records concerning Tradewinds' substantive transactions were inadequate;

• the fact that a single individual served as the entity's sole member and manager facilitated misuse;

• the entity was thinly capitalized;

• undocumented infusions of cash were required to pay all of Tradewinds' operating expenses, including its litigation expenses;

• Tradewinds was never operated as an active business;

• legal formalities were disregarded;

• Freeman paid Tradewinds' debts without characterizing the transactions;

• Tradewinds' assets, including the airplane, were used for nonentity purposes in that the plane was used by Aircraft Storage LLC, without agreement or compensation;

• Tradewinds was operated as a mere assetless shell, and the proceeds of the sale of its only significant asset, the airplane, were diverted from the entity to Freeman's personal account.

Defendants maintain that the court erred in finding that the first prong was satisfied because Freeman did not use Tradewinds' assets as his own. However, although the trial court recognized that “most of the examples of commingling were the use of the member's personal assets to satisfy the entity's obligations,” it also noted that proceeds from the sale of the entity's only significant asset, the airplane, were diverted from the entity to Freeman's personal account.

¶ 11 Defendants further argue that the court erred in not recognizing that (1) limited liability companies have fewer restrictions than corporations concerning maintaining formal corporate records, (2) member-owners are permitted to fund LLCs, (3) thin capitalization is not a reason to disregard the corporate form, and (4) third-party payment of attorney fees is proper. See, e.g., § 7–80–107(2), C.R.S.2011 (“the failure of a limited liability company to observe the formalities or requirements relating to the management of its business and affairs is not in itself a ground for imposing personal liability on the members for liabilities of the limited liability company”); 1 Fletcher's Cyclopedia of the Law of Corporations § 41.35 (“a sole shareholder will not likely be suspect merely because he or she conducts business in an informal manner”); 2 Ribstein and Keatinge on Limited Liability Companies § 12.3 (“veil piercing on the ground of inadequate capitalization is even less likely for LLCs than corporations”; “LLCs normally receive little funding apart from member contributions”; “LLCs might be distinguished from corporations regarding the likelihood that the veil will be pierced for failure to observe formalities”); see also Colo. RPC 1.8(f) (allowing third-party attorney fee payment arrangements). However, the court considered the appropriate factors and its findings support a conclusion that Tradewinds was Freeman's alter ego. See also Sheffield Services Co., 211 P.3d at 720–21 (extending veil piercing to LLCs and identifying alter ego factors).

B. Defeat of a Rightful Claim

¶ 12 Defendants contend that the court erred in finding that the second prong of veil piercing was satisfied because the court did not find wrongful intent or bad faith. We disagree.

¶ 13 “The second prong of the veil-piercing test is whether justice requires recognizing the substance of the relationship between the corporation and the person or entity sought to be held liable over the form because the corporate fiction was ‘used to perpetrate a fraud or defeat a rightful claim.’ ” McCallum Family L.L.C., 221 P.3d at 78 (quoting In re Phillips, 139 P.3d 639, 644 (Colo.2006)). Defendants have not cited any Colorado case, and we are aware of none, establishing that a party seeking to pierce the corporate veil must show wrongful intent. We conclude that showing that the corporate form was used to defeat a creditor's rightful claim is sufficient and further proof of wrongful intent or bad faith is not required.

¶ 14 Here, in finding that the corporate form was used to defeat a rightful claim, the court relied on Tradewinds' sale of its only asset, the airplane, and diversion of the proceeds to Freeman during the litigation with Martin. Defendants argue that the airplane's sale in 2007 does not support the second prong because Martin did not have a rightful claim until the cost award in his favor was entered in 2009. We conclude that defeating a potential creditor's claim is sufficient to support the second prong. We further conclude, as a matter of first impression, that wrongful intent or bad faith need not be shown to pierce the LLC veil.

¶ 15 Any party engaged in litigation is exposed to potential liability. See, e.g., C.R.C.P. 54(d) (authorizing award of costs to prevailing party).

¶ 16 Here, Freeman drained Tradewinds of all assets during litigation, even though it was exposed to potential liability because it had sued Martin. Leaving Tradewinds without any assets would have, without a finding that veil piercing was appropriate, defeated any of Martin's potential valid claims. We conclude that transferring all of the LLC's assets to defeat a rightful creditor's potential claim is sufficient to support piercing the corporate veil. See McCallum Family L.L.C., 221 P.3d at 78 (creditor seeking to pierce the veil must show an effect on its lawful rights as a creditor resulting from the corporate form's abuse). We therefore conclude that the trial court did not err in concluding that the sale of the only asset and transfer of the proceeds to Freeman satisfied the second prong.

¶ 17 Relying on the court's finding that, “to the best of his [Freeman's]...