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Appellate Court reverses district court’s finding of alter ego in Sedgwick Properties Development Corporation v. Christopher Hinds (2019WL2865935)
Division V of the Colorado Court of Appeals addressed, for the first time, corporate veil-piercing in the context of a single-member, single-purpose LLC that is managed under a contract by another company. On July 3, 2019, the Court of Appeals reversed the order of the Honorable Ross B. Buchannan, Denver District Court Judge (17CA2102), who held that Plaintiff/Appellee Christopher Hinds satisfied the elements required to pierce the corporate veil of Sedgwick Properties Development Corporation (“Sedgwick”).
Defendant 1950 Logan, LLC (“1950 Logan”) was the developer of a building located at 1950 Logan Street, in Denver, called The Tower on the Park (“Project”), which contained 141 individually owned condominium units. The Project was completed in 2006. 1950 Logan was a single-purpose entity created for the construction of the Project, which is a common practice in the construction industry. After the units were sold in 2006, the LLC wrapped up operations.
Sedgwick is a Chicago based corporation and was the initial manager for 1950 Logan. It had no ownership interest in 1950 Logan. 1950 Logan paid Sedgwick a fee in exchange for development services, which included marketing, general coordination of construction of the development of the Project, and lender management. Sedgwick did not invest, loan, or otherwise provide any monies to 1950 Logan for any purpose. As it was not an owner, Sedgwick did not receive, nor was it entitled to, any partnership distributions from 1950 Logan.
In October 2011, Plaintiff/Appellee, Christopher Hinds, purchased a unit in the Project from a previous purchaser. This was five years after 1950 Logan completed the Project. Mr. Hinds, who uses a wheelchair, bought the unit assuming the seven handicap parking spaces would be available for his use, in addition to the parking spot in the general parking area that was part of his unit purchase. The handicap parking spots, which were individually deeded and owned by 1950 Logan, were sold to residents of the Project after it was determined that no handicap residents required a handicap parking space. The sales of these parking spaces were recorded, and Mr. Hinds was on record notice of this public record when he bought his unit.
At the time of the sale of these parking spots, Colorado law did not prohibit their sale. C.R.S. § 42-4-1208(3)(b) stated that the owner of private property available for public use “may request” the installation of official signs identifying parking spaces reserved for persons with disabilities. The parking lot at the Project was not available for public use. In 2014, Mr. Hinds and his attorney, Joseph Salazar, a state representative, sponsored House Bill 14-1029 to repeal and replace this law. When signed into law by Governor Hickenlooper, this law removed the provision above, making the law clear that any handicap parking spot, whether on public or private lot, must allow handicap parking. Furthermore, section 2(e)(III) was added to require “real property with multiple-family dwellings affixed and with reserved parking shall retain the reserved parking as commonly owned for the tenants…This…does not prohibit the sale of all commonly owned property so long as the reserved parking is not severed from the other elements.” Thus, when the parking spots were sold, the existing law suggested such a sale was not unlawful.
Prior to the change in the handicap parking law, in 2013, the Colorado Civil Rights Commission (“CCRC”) filed an action against 1950 Logan, 1950 Logan Condominiums Condominium Association (“Association”), and its management company, St. Charles Town Company (“St. Charles”), with claims that each violated Christopher Hinds’ civil rights. The Complaint alleged seven claims of violations of Colorado’s Fair Housing Act, C.R.S. § 24-34-501, et seq. (“FHA”). The allegations stated that 1950 Logan, as developer of the Project, sold seven handicap designated parking spaces and one non-designated parking space to owners with no disabilities. The Association and St. Charles eventually settled the claims with the CCRC.
As 1950 Logan was a long since defunct company, with no assets, it did not respond to the CCRC’s complaint. As such, the CCRC chose not to pursue 1950 Logan and dismissed its claims against 1950 Logan. Mr. Hinds filed a Motion to Intervene to pursue 1950 Logan. On December 10, 2014, the district court issued an Order for Default Judgment in favor of Intervenor Christopher Hinds against 1950 Logan. Mr. Hinds issued a Writ of Garnishment to Sedgwick. Sedgwick responded that it had no personal property owed to or owned by 1950 Logan in its possession or control. Intervenor filed an Affidavit and Traverse of Creditor against Sedgwick. On December 5, 2015, the district court ordered a hearing on the traverse and found that Mr. Hinds properly put into issue whether Sedgwick is the alter ego of 1950 Logan.
On June 20, 2017, the court held a traverse hearing. The underlying facts were not contested because default had entered, and the court treated the allegations as established for purposes of the hearing. On June 22, 2017, the district court found that Intervenor had satisfied the elements to pierce the corporate veil against Sedgwick, citing In re Phillips, 139 P.3d 639, 644 (Colo. 2006) and Martin v. Freeman, 272 P.3d 1182 (Colo. App. 2012). Pursuant to C.R.C.P. 103(8)(3)(A), the court held Sedgwick liable to 1950 Logan and entered judgment in favor of 1950 Logan against Sedgwick for the use and benefit of Mr. Hinds.
Sedgwick filed its appeal asserting the traverse hearing violated its right to due process and that Hinds had not satisfied the elements to pierce the corporate veil. While the appellate court found no due process violation, it found Plaintiff/Appellee did not present sufficient evidence to support a finding that Sedgwick was 1950 Logan’s alter ego. The Court reversed the district court’s order without addressing the other elements required for piercing the corporate veil.
Due Process. The Court disagreed with Sedgwick’s claim that the traverse hearing was insufficient to protect Sedgwick’s due process rights. The Court found nothing in Colorado law prohibits a judgment creditor from asserting a claim to pierce the corporate veil in a garnishment proceeding. Sedgwick Properties at ¶ 10. The Court found the garnishment proceeding adequately protected Sedgwick’s due process rights. Id. (citing Maddalone v. C.D.C., Inc., 765 P.2d 1047, 1049 (Colo. App. 1988)). Sedgwick Properties at ¶ 12. Garnishment procedures under C.R.C.P. 103 accord with due process and fully protect a garnishee who denies liability for debt as a garnishee is treated no differently than if it had been sued directly on the debt. Sedgwick had the right to deny the debt, engage in discovery, and have an adverse hearing in which Mr. Hinds must prove the allegations by a preponderance of the evidence. Id.
Corporate Veil-Piercing of a Single-Member, Single-Purpose LLC. Colorado’s appellate courts had not previously addressed corporate veil-piercing in the context of a single-member, single-purpose LLC that is managed under a contract by another company. Sedgwick Properties at ¶ 16.
Burden of Proof. The Court first addressed the burden of proof for veil-piercing, which has been the subject of inconsistent judicial precedent. In Phillips, supra, the Colorado Supreme Court said the burden of proof is clear and convincing evidence. But the same court in Griffith v. SSC Pueblo Belmont Operating Co. LLC, 381 P.3d 308 (Colo. 2016), concluded the language from Phillips was mere dictum and applied C.R.S. 13-25-127(1) to find the burden of proof in any civil action shall be by preponderance of the evidence. Sedgwick Properties at ¶ 19. A year later, in Stockdale v. Ellsworth, 407 P.3d 571, (Colo. 2017), Colorado’s Supreme Court held the standard to pierce the corporate veil is clear and convincing evidence. The appellate court noted there was no reasoning provided by the Colorado Supreme Court as to why the burden of proof is contrary to that set out in C.R.S. § 13-25-127(1). Therefore, the appellate court concluded this language from Stockdale was dictum and applied Griffith’s ruling that the burden is by preponderance of the evidence, as required by statue. Sedgwick Properties at ¶ 20.
Elements of Veil Piercing. A court must conduct a three-party inquiry: 1) whether the corporate entity is the alter ego of the person or entity in issue; 2) whether justice requires recognizing the substance of the relationship person or entity sought to be held liable and the corporation over the form, because the corporate fiction was used to perpetrate a fraud or defeat a rightful claim; and 3) whether an equitable result will be achieved by disregarding the corporate form. Sedgwick Properties at ¶ 21, (citing Phillips at 644). The majority opinion focused on the first element. In determining the alter ego of an entity, courts consider a variety of factors, including whether: 1) the corporation was operated as a distinct business entity; 2) funds and asserts were commingled; 3) adequate corporate records were maintained; 4) the nature and form of the entity’s ownership and control facilitated misuse by an insider; 5) the business was thinly capitalized; 6) the corporation was used a mere shell; 7) legal formalities were disregarded; and 8) corporate funds were used for noncorporate purposes. Sedgwick Properties at ¶ 32, (citing Phillips at 644).
The appellate court found the district court’s analysis floundered on the assumption that a single-member, single-purpose LLC is subject to the same veil-piercing analysis generally applied to corporations, without taking into account the characteristics of such LLCs. The court noted a dearth of precedent addressing those characteristics, citing C.R.S. § 7-80-107(2) – the failure of an LLC to observe the formalities or requirements relating to the management of the business is not in itself a ground for imposing personal liability on the members. Sedgwick Properties at ¶ 34. Where, as here, management of the LLC is provided under contract by a management company, traditional veil-piercing factors may be even harder to apply. Sedgwick Properties at ¶ 37.
The appellate court concluded that the record, considered as a whole, did not support an alter ego finding that would permit piercing 1950 Logan’s corporate veil. The evidence showed numerous real estate projects for which Sedgwick provided the same types of development services it provided for 190 Logan. The district court framed the first issue as “whether…the LLC is the alter ego of its manager,” apparently referencing Sedgwick. Sedgwick Properties at ¶ 40. It was unclear to the appellate court if the district court recognized that Sedgwick was the manager under a management contract and was not an owner-manager of the LLC, as defined by C.R.S. § 7-80-102(8). Id.
In review of the alter ego findings, the appellate court addressed the following elements:
1. Ownership, Control, and Unity of Interest. The appellate court took issue with the district court finding that Sedgwick controlled 1950 Logan when the evidence showed Sedgwick had no interest in this entity. Sedgwick was hired under a contract to provide management services only, as permitted by C.R.S. § 7-80-102. Sedgwick Properties at ¶ 43. The district court did not find that Sedgwick and its principal, Marty Paris, were the alter egos of each other. The appellate court felt the district court “conflated the two in concluding that Sedgwick’s assets are available to satisfy the judgment against 1950 Logan – even though it found that Sedgwick had no interest in 1950 Logan. Sedgwick Properties at ¶ 45. The court’s findings did not show control by Sedgwick beyond what would be expected under the contractual role of manager of the LLC. Also, the appellate court noted the court appeared to ignore other evidence that showed Sedgwick did not exercise control over 1950 Logan, to include evidence that Sedgwick had no ownership interest in 1950 Logan, never made a profit from the Project, and had no assets of 1950 Logan. Sedgwick never controlled the $30 million borrowed from institutional investors to build the Project and had its own assets and bank accounts. Sedgwick Properties at ¶ 48. The appellate court held, “The record simply does not support the court’s finding that Sedgwick had the type of ownership and control over 1950 Logan necessary to establish alter ego status.” Sedgwick Properties at ¶ 49.
2. Failure to Observe Corporate Formalities. Regarding the corporate formalities, the appellate court noted that LLCs are operated with less formality than traditional corporations and may not have meetings of members or managers, or observe other procedures required for corporations. Sedgwick Properties at ¶ 52, (citing 1 Stephen A. Hess, Colorado Practice Series: Methods of Practice & 5:9, Westlaw (8th ed. database updated May 2019)). Compared to a corporation, there is no requirement for annual meetings of the members of an LLC under the LLC Act. Id.
3. Whether the Entity’s Form Facilities Misuse by an Insider. The district court found that multiple entities were rolled into one for purposes of operation and for purposes of filing a single tax return. C.R.S. § 7-80-107(3) states an LLC’s status for federal tax purposes does not affect its status as a distinct entity. Sedgwick Properties at ¶ 53. Even if true, those circumstances did nothing to establish Sedgwick as an alter ego of 1950 Logan.
4. Mere Shell. The district court found 1950 Logan did not constitute a mere shell. Sedgwick Properties at ¶ 55, (citing Phillips, supra at 644).
5. Capitalization. Undercapitalization of the LLC is one indicator that may support piercing of the corporate veil. McCallum family, L.L.C. v. Winger, 221 P.3d 69, 76 (Colo. App. 2009). The appellate court did not agree with the district court’s heavy reliance on its finding that 1950 Logan was thinly capitalized. 1950 Logan owned the land for the Project, raised more than $1 million from investors, obtained $30 million in funding from major institutional lenders, and paid off the loans. Sedgwick Properties at ¶ 58. These facts showed 1950 Logan was not thinly capitalized. The appellate court cited a series of cases to show undercapitalization, such as the inability to procure a loan, the entity never had assets, a net worth, or bank accounts, or the capital was illusory or trifling compared with the business to be done and the risk of loss. Id. A lender would not have provided the loans if 1950 Logan could not repay the loan during the useful life of the LLC. Sedgwick Properties at ¶ 59. The district court was critical because 1950 Logan lacked funds to pay a judgment entered in favor of Mr. Hinds. However, the record showed by the time judgment had entered, 1950 Logan had, years before, satisfied its single purpose and had wound down operations. The appellate court held, “Undercapitalization is not determined whether a single-purpose LLC might be able to pay liabilities that are incurred only after the LLC has reached the end of its useful life and has ceased operating.” Sedgwick Propertiesat ¶ 60.
6. Commingling of Assets and use of Corporate Funds for Noncorporate Purposes. The only evidence the district court relied on for a finding of asset commingling was a settlement of the Association’s construction defect lawsuit. Several named defendants jointly entered into the agreement, which the district court recognized was a “drafting convenience.” Because the settlement funds came from 1950 Logan’s bank account to extinguish liability, if any, of Sedgwick and the other defendants, the district court concluded 1950 Logan’s funds were available to Sedgwick. Sedgwick Properties at ¶ 61. The appellate court found no legal authority that supports a conclusion that a joint settlement of potential liabilities is an indicator of alter ego status. On the contrary, it found that it is common knowledge among lawyers and judges that joint settlements that benefit unrelated parties often take place, especially where cross-claims among the settling entities may be anticipated. Sedgwick Properties at ¶ 62.
The appellate court concluded the evidence presented to the district court was insufficient to establish, even by a preponderance of the evidence, that 1950 Logan is the alter ego of Sedgwick and remanded the case to the district court for entry of judgment for Sedgwick.
Judge Jerry N. Jones concurred and added that the district court’s findings should lead to the conclusion that Mr. Hinds also failed to prove the second requirement for piercing the corporate veil – that the corporate form was used to perpetrate a fraud or defeat a rightful claim. Sedgwick Properties at ¶ 66 (citing Phillips, supra at 644 (quoting Contractors Heating & Supply Co. v. Scherb, 432 P.2d 237, 239 (Colo. 1967)). In Martin, supra, the appellate court held this requirement can be shown even if there was no wrongful conduct in the use of the corporate form. Sedgwick Properties at ¶ 67. Judge Jones dissented in Martin and continues to believe that the majority’s holding is contrary to the Colorado Supreme Court precedent. Id. In his view, that precedent requires a showing that the corporate form was used in a manner that, if not criminal, was at least unlawful or intended to defeat a claim. Id. (citing Martin at ¶ 33). In this case, the district court found there was no evidence of fraud and no wrongful motive or intent. Sedgwick Properties at ¶ 68. Absent such evidence, there is no basis to conclude that 1950 Logan’s corporate form was used to perpetrate a fraud or defeat a rightful claim. In a footnote, Judge Jones noted that he did not fault the district court for relying on the majority’s decision in Martin.
The appellate court found that a single-member, single-purpose LLC, managed by a separate management company, must undergo the same analysis as any other limited liability company, and not a corporation. In addition, it provided further, and much needed, context into the elements of piercing a corporate veil, especially concerning the elements of ownership, control, and unity of interest, and capitalization.