Tuesday, March 2, 2010

New Colorado Case Says Members and Managers of an LLC are Directly Liable to Creditors for Excessive Distributions

Under Colorado Revised Statute (“CRS”) Section 7-108-403, a director of a corporation who agrees to a distribution that prevents the corporation from being able to pay its debts is personally liable to the corporation for the extra amount.  But in addition, Colorado courts have determined that creditors can proceed against the directors who make the distribution in a lawsuit to recover the excessive distribution.

Colorado Developments Regarding LLCs

Now, the Colorado Court of Appeals in Colborne Corp. v. Weinstein, 2010 WL 185416, No. 09CA0724 (Colo. Ct. App. Jan. 21, 2010)(link here), has held that, by analogy, limited liability companies (LLCs) are under the same basic rules.Take Money Hand

Specifically, under CRS Section 7-80-606 Members of an LLC are liable to the LLC for excessive distributions knowingly made to them.  In the Colborne case, creditors sued the Members and Managers of an LLC under Section 7-80-606 asserting that the Members and Managers should also be liable to the creditors, not just the LLC, for any excessive distribution.  The Members and Managers of the LLC argued that the statute only allowed the LLC to recover from them, not the creditors.  While the lower court agreed with the Members and Managers, the Court of Appeals has now stated it agrees with the creditors, and has sent the case back to the lower court for more proceedings.  Accordingly, the creditors are being allowed to bring a case directly against the Members and Managers to hold them liable for the excessive distribution.

Conclusion and Summary

On the down side, this does mean that LLC Members and Managers cannot hide behind the LLC entity if they give themselves all of the money from the LLC through a distribution without paying off their creditors. 

However, there is also a lot of upside.  First, if the rule prevails that the creditors can proceed against Members and Managers for an excessive distribution, creditors will be more likely to lend money to such entities knowing that they will have some recourse if the Members and Managers start making large distributions that could deplete the LLC’s ability to pay them back.  Second, as the LLC statutes are tested in court, and the court’s analogize more with the corporate law which has been around longer and already been tested more, the LLC law becomes more stable and predictable.  This lowers the risk and potential cost of creating and running a successful LLC.

Overall, the case suggests the courts in Colorado are heading in the right direction regarding the responsibilities of the Members and Managers of LLCs.

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