One of the key reasons for forming a Colorado LLC is the protection of its members and managers from liability to creditors and lawsuit judgments. When properly created and maintained, a LLC provides a corporate veil of liability protection between a member’s personal assets (i.e., home, car, bank accounts, etc.) and the LLC’s business assets.  However, the corporate veil may be pierced where the business is simply an alter ego of the member’s personal activities or where the member simply used the corporate shield to defraud their legitimate creditors. When speaking of the corporate veil, I tend to think of it more as a corporate shield. A shield which fends off attacks on one’s personal assets when an adversary is successful in a lawsuit against the company.

Although it is extremely important for LLCs to adhere to the management provisions in their Operating Agreement (voting, meetings, etc.), failure to do so is not enough to pierce the veil. The two main factors that Colorado courts evaluate on piercing the veil cases are 1) whether the LLC’s capital is grossly inadequate for its anticipated business operations and 2) whether there is commingling of funds between the LLC entity and its members or managers.

An LLC must have enough capital (cash, property, and sometimes services provided to the business) at its inception and during its operation to sufficiently carry on its business operations. Under Colorado LLC law, if the LLC’s capital is “grossly inadequate for its anticipated business operations”, the corporate shield may be overcome. How much of a capital contribution is needed? It depends on the facts and circumstances for each business. Some LLC’s are started with only a few hundred bucks from each member. The initial contributions pay the company’s startup expenses until the company begins to generate enough cash flow to stand on its own two feet. An example of undercapitalization would be an LLC initially capitalized with a few thousand dollars, that proceeds to invest millions of dollars supplied by its members. Additionally, there should always be enough working capital in the LLC to sustain the business. An insolvent LLC is on shaky ground when it comes to liability protection.  Therefore, allowing for additional capital contributions from the members (beyond the initial capitalization of the business) in the LLCs Operating Agreement should be considered.

The other major factor is whether the business commingled funds with its members/managers or with other entities (i.e., other LLCs or Corporations also owned by the members). Are the assets of the business simply treated like they are the member(s)? Is the company debit card used for personal purchases?  If there are loans from the LLC to the members, are they legitimate and is there a written agreement in place? Are the members loosey-goosey with their accounting and books? If the answer is yes to any of these questions, personal liability for the LLC’s members and managers may become an unfortunate reality. 

 

In summary, when the LLC is practically disregarded as a separate legal entity, the corporate shield is not likely to protect a business owner’s personal assets from lawsuits or creditors.