Thursday, February 23, 2012

No Happy Landing After Airplane Sale

Ben Engel
Business Lawyer

Dean C. B. Freeman’s LLC sold its airplane for $300,000 in 2007. It didn’t turn out to be a happy landing.

Mr. Freeman was the sole member and manager of Tradewinds Group, LLC. According to a recent decision by the Colorado Court of Appeals, in 2006 Tradewinds sued Robert C. Martin for allegedly breaching a contract to build an airplane hangar. While the lawsuit was pending, Tradewinds sold the airplane, its only meaningful asset, and distributed the sale proceeds to Freeman, who was paying its litigation expenses. Tradewinds initially won the lawsuit, but that judgment was reversed on appeal. Mr. Martin was declared the prevailing party and was awarded $36,645.40 in costs.

But by that time, the LLC had no assets to pay, due to the sale of the airplane. Normally, an LLC owner is not responsible for the LLC’s debts, but courts can pierce that veil of protection in certain cases. Martin successfully sued Freeman personally, persuading the court to pierce the veil and hold Freeman personally liable for the cost award because Freeman had gotten the airplane sale proceeds.

Freeman appealed, resulting in turbulence within the Colorado appeals court. Two judges upheld the veil piercing, holding Freeman liable because he received the airplane sale proceeds at a time when the LLC was subject to potential liability from its lawsuit against, such as the cost award. The court said that action defeated any rightful potential claims by Martin.

But one judge dissented, stating that the veil should only be pierced if the LLC form was misused in a manner that was criminal, unlawful or intended to defeat a creditor’s claim, which he said didn’t happen here. He pointed out that when Freeman received the sale proceeds, he believed Tradewinds still had enough value to cover any reasonably possible LLC debts on the horizon. He also said that after a company’s primary asset is sold, it makes sense for the company to be dissolved and its assets distributed to the owners. He also noted that the sale took place two years before any obligation to Martin arose, and Martin had asserted no counterclaim in the underlying lawsuit.

Legal brief.  The case discussed is Martin v. Freeman (Colo. Ct. App. Div. VII, February 2, 2012). Appeal of trial court judgment piercing LLC veil. Held, judgment affirmed. Defendant held LLC’s alter ego. On matter of first impression, use of corporate form to defeat rightful claim held not to require showing of wrongful intent or bad faith. Dissenting judge believed that rightful claim prong of veil piercing test not satisfied by showing of cause and effect absent wrongful conduct.

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