Recently, I have had a number of calls from general contractor clients complaining that one or more of their subcontractors have gone broke, leaving a bunch of unpaid suppliers. So what do they do? There are two possible solutions that might work if their owners have personal wealth or the subcontractors are corporations or limited liability companies.
It may then be possible to prove (1) that the owners used payments made to their companies for something other than the payments to their suppliers, or (2) that their companies were not properly organized or maintained separate and apart from themselves.
The first remedy would lie under the Colorado Trust Fund Statute, and the second might be under the legal doctrine of “piercing the corporate veil.”
To promote investment in businesses, the law provides for protection against personal liability for business obligations for those who incorporate their businesses or form them into limited liability companies, limited partnerships or other business forms. If properly organized and maintained, the owners (shareholders, members, limited partners) of those entities are not likely to be responsible for the typical business obligations and liabilities of those companies, with certain exceptions.
However, to obtain those protections, the business must be properly organized and maintained as an entity separate from its owners. It must also carefully identify itself as one of those business forms in its contracts, stationery and other documents. When the entity is formed, it must be capitalized with sufficient funds to carry on its business, and it must maintain separate bank accounts and separate books and records.
Forming a corporation, a limited liability company, a limited partnership or other organization is easily accomplished by having the necessary papers prepared and filed with the secretary of state. However, that’s only the beginning because maintenance of the organization is critical if the owner or owners wish to avoid personal liability for the entity’s debts.
The consequence of failing to properly organize and maintain a separate organization may result in the loss of protection from personal liability. That loss may be established in court under the legal theory of “piercing the corporate veil.”
If a creditor of the business is able to establish that it was not properly capitalized, was not properly organized, it did not properly identify itself as a separate entity, or it did not maintain separate bank accounts, books and records, then the business owners may be held personally liable for its debts. In that situation, the law characterizes the business as merely the alter ego of the owner or owners.
A recent example of piercing the corporate veil involved a notorious Denver project, the Beauvallon, located at 11th and Lincoln streets near downtown Denver—the project that recently had a complete facelift and millions of dollars spent for remediation of construction defects. Notwithstanding, the general contractor was successful in recovering an arbitration award against the developer corporation and, having proven that the corporation was but a shell (alter ego) of its owner, the contractor recovered a personal judgment against the corporate owner-shareholder as well.
To be successful with a “piercing the corporate veil” claim, it is necessary to prove that the owner(s) had failed to properly organize, capitalize and maintain the company as a separate entity. As a practical matter, it would be useless to make that effort if the owner does not have enough assets to pay a judgment if the claim is successful.
Albert B. Wolf is a principal in the Denver law firm of Wolf Slatkin & Madison P.C. This column was written with the intent of providing general legal information intended to be reasonably accurate although not comprehensive. Readers are therefore urged to consult their attorneys for any specific legal advice they may desire concerning the subject matter of this column.