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
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.