Chapter 7 - § 7.2 • OWNER LIABILITY FOR DEBTS OF AN ENTITY

• Jurisdiction: Colorado

§ 7.2 • OWNER LIABILITY FOR DEBTS OF AN ENTITY

§ 7.2.1—General

In contrast to Chapter 6, "Creditor Rights," which discusses issues applicable when a creditor of a member or partner seeks to enforce an obligation of the member or partner against the debtor's membership interest or partnership interest, this chapter discusses situations in which a member or partner may be liable for debts of the LLC or partnership.

§ 7.2.2—Statutory Provisions Regarding Liability of Owner for Debts of LLC, Partnership, or LP

Except for partnerships that are not LLPs, the LLC Act, CULPA, CUPL, and CUPA provide protection (with some exceptions) to members and partners against liability for obligations of the entity. General partners of limited partnerships that are not LLLPs, however, have no statutory protection. See the first sentence of "Partnerships" in this § 7.2.2.

LLCs

The LLC Act at § 7-80-705 states the general rule that "[m]embers and managers of limited liability companies are not liable under a judgment, decree, or order of a court, or in any other manner, for a debt, obligation, or liability of the limited liability company." However, as discussed in §§ 7.2.3, "Veil Piercing in General," through 7.2.7, "Piercing the Veil of an LLP or LLLP," members may be liable for obligations of an LLC if a veil-piercing claim succeeds. Section 7-80-107(1) recognizes this possibility:

In any case in which a party seeks to hold the members of a limited liability company personally responsible for the alleged improper actions of the limited liability company, the court shall apply the case law which interprets the conditions and circumstances under which the corporate veil of a corporation may be pierced under Colorado law.

Section 7-80-107(1) and the case law interpreting it are discussed in "Colorado Statutory Provisions" in § 7.2.4.

Members often agree to make contributions over time, or to make additional contributions if called for by the governing persons. Section 7-80-502(3) of the LLC Act provides that a member's promise to contribute to an LLC is not enforceable unless set out in a writing signed by the member. However, pursuant to § 7-80-502(1), if a member has made an enforceable promise to contribute cash or property or to perform services, unless otherwise provided in the operating agreement, the member is obligated to perform on the promise even if the member is unable to perform because of death, disability, or any other reason. If a member does not make a required contribution of property or services, such member will be obligated at the option of the LLC to contribute cash equal to that portion of the value, as stated in the LLC's records required to be kept by § 7-80-408, of such contribution that has not been made.

Section 7-80-502(2) states that

[t]he obligation of a member to make a contribution or return money or other property paid or distributed in violation of this article may be compromised only by consent in writing of all the members. Notwithstanding the compromise, a creditor of a limited liability company who extends credit or otherwise acts in reliance on the original obligation may enforce the original obligation. [Emphasis supplied.]¹

Partnerships

In the case of partnerships that are not LLPs or LLLPs, the general partners are jointly and severally liable for obligations of the partnership.² A limited partner of a limited partnership that is not an LLLP is not liable for obligations of the partnership unless the limited partner is also a general partner or takes part in control of the partnership.³ The question of participating in the control of the business is fundamental for a limited partner to avoid liability as a general partner if the limited partnership is not an LLLP.⁴ In explanation, § 7-62-303(2) states that a limited partner does not participate in the control of the business within the meaning of subsection (1) solely by doing one or more of the following:

(a) Being a contractor for or an agent or employee of the limited partnership or of a general partner;
(b) Being an officer, director, or shareholder of a corporate general partner;
(c) Consulting with and advising a general partner with respect to the business of the limited partnership;
(d) Acting as surety for the limited partnership or guaranteeing or assuming one or more specific obligations of the limited partnership or providing collateral for an obligation of the limited partnership;
(e) Bringing an action in the right of a limited partnership to recover a judgment in its favor pursuant to part 10 of this article;
(f) Calling, requesting, or participating in a meeting of the partners;
(g) Proposing or approving or disapproving, by voting or otherwise, one or more of the following matters:

(I) The dissolution and winding up or continuation of the limited partnership;
(II) The sale, exchange, lease, mortgage, pledge, or other transfer of any assets of the limited partnership;
(III) The incurrence of indebtedness by the limited partnership;
(IV) A change in the nature of the business;
(V) The admission or removal of a partner;
(VI) A transaction or other matter involving an actual or potential conflict of interest;
(VII) An amendment to the partnership agreement or certificate of limited partnership; or
(VIII) Such other matters as are stated in writing in the partnership agreement;

(h) Winding up the limited partnership pursuant to section 7-62-803; or
(i) Exercising any right or power permitted to limited partners under this article and not specifically enumerated in this subsection (2).

Section 7-62-303(3) states:

The enumeration in subsection (2) of this section does not mean that the possession or exercise of any other powers by a limited partner constitutes participation by the limited partner in the business of the limited partnership.

Similar to CULPA, CULPL also provides that "[a] limited partner shall not become liable as a general partner unless, in addition to the exercise of the limited partner's rights and powers as a limited partner, the limited partner takes part in the control of the business."⁵ In a 1988 opinion involving a CULPL limited partnership, the Colorado Supreme Court cited § 7-61-108 and, in discussing whether the limited partner there had taken part in the management of the CULPL limited partnership to a degree sufficient to result in liability as a general partner, the court cited the provisions of CULPA discussed above enumerating various actions that will not cause a limited partner to be considered as taking part in management, but the court did not appear to rely on the CULPA provisions for its holding that the limited partner in the case before it had not taken part in management to a significant degree.⁶

LLPs and LLLPs

Partners of an LLP are not liable for obligations of the partnership that are incurred while it is an LLP.⁷ General partners of an LLLP are not liable for obligations of the partnership that are incurred while it is an LLLP.⁸ Limited partners of an LLLP are not liable for obligations of the partnership that are incurred while it is an LLLP even if they take part in control of the partnership.⁹

§ 7.2.3—Veil Piercing in General¹⁰

In addition to issues arising out of a member's or a partner's creditor's attempts to reach the membership or partnership interest discussed in Chapter 6, "Creditor Rights," a related issue for LLCs, LLPs, and LPs is the protection of members, managers, and partners from liability to creditors of the entity. Although LLCs, LLPs, and LPs are often described as limited liability entities, even if the statutes did not contain the liability limitations discussed in § 7.2.2, "Statutory Provisions Regarding Liability of Owner for Debts of LLC, Partnership, or LP," debts of the entity ordinarily would not be considered those of the entity's owners because the entity is a separate legal entity.¹¹ Courts developed piercing the veil in corporate cases over a century ago as an equitable remedy to prevent perceived misuses of the separate legal entity status of the corporate form.¹² In the corporate context, courts may pierce the veil where a subsidiary corporation is merely an alter ego or agent of the corporate parent, where the corporation is merely the alter ego of the shareholder, or where the corporate shield is being used to defraud creditors.¹³ Veil piercing, when properly applied, is a remedy and is not itself a separate cause of action. One federal appeals court has held that "before bringing an action to pierce the corporate veil, the plaintiff must 'first obtain[] a judgment against the corporation.'"¹⁴ These authors have, however, seen numerous instances where plaintiffs plead the remedy at the same time they plead the causes of action expected to lead to the liability.

Jonathan Macey and Joshua Mitts assert that their analysis shows that whatever rationale may have been stated in opinions, "the entire universe of piercing cases can be explained as judicial efforts to remedy one"¹⁵ of three problems:

1) Courts pierce the corporate veil "to bring corporate actors' behavior into conformity with a particular statutory scheme";¹⁶
2) Courts "also pierce to remedy what appears to be fraudulent conduct that does not satisfy the strict elements of common law fraud";¹⁷ and
3) Courts pierce the corporate veil for "the promotion of what" Macey and Mitts term "accepted bankruptcy values."¹⁸

Note that courts may apply a lesser standard to veil piercing and alter ego if the issue is personal jurisdiction.¹⁹

Some commentators have asserted that veil piercing "seems to happen freakishly. Like lighting, it is rare, severe, and unprincipled."²⁰ These authors believe that case analysis shows that although veil piercing may be rare and severe, there are principles that are, or should be, applied by courts in these cases. Veil piercing should be rare because limited liability and the separateness of entities and their owners are intended purposes of the LLC Act and...