The purpose of Colorado’s Limited Liability Company Act, Colo. Rev. Stat. § 7-80-606 (the “Act”), is, in part, to protect creditors from members who raid an LLC’s assets before creditors are paid. The Act bars LLCs from making distributions to members if the LLC is insolvent or if the distribution will make the LLC insolvent. A member who knowingly receives a distribution in violation of the Act is liable to the LLC to return the distribution. Colo. Rev. Stat. § 7-80-606(2). However, the Act says nothing about an offending member being individually liable to creditors themselves. This creates a problem when the LLC members who authorize the distribution are the same member who receive the distribution, and, therefore, have no interest in suing themselves to “recover.” Under these circumstances, may a creditor sue the offending members under the Colorado Limited Liability Company Act?
In Colborne Corp. v. Weinstein, 2010 WL 185416 (Colo. App. Jan. 21, 2010), the Colorado Court of Appeals answered in the affirmative and reasoned that to hold otherwise would substantially undermine the purpose of the Act. In Weinstein, the plaintiff creditor brought suit against two members of the LLC debtor pursuant to the Act, alleging that the members authorized and received a $200,000 distribution that rendered the LLC insolvent, thereby frustrating the plaintiff’s efforts to collect. In the trial court, the LLC sought (and obtained) dismissal of the claims on the grounds that the Act only allows for recovery of improper member distributions by the LLC and not by third-party creditors. On appeal, the Colorado Court of Appeals reversed and held that policy considerations underlying the Act supported extending a right of action to the creditors. Colborne Corp. v. Weinstein, 2010 WL 185416 (Colo. App. Jan. 21, 2010).
To reach this conclusion, the Court looked to its interpretation of Colorado’s Business Corporation Act, Colo. Rev. Stat. § 7-108-403(1) (“CBCA”),in Paratransit Risk Retention Group Ins. Co. v. Kamins, 160 P.3d 307 (Colo. App. 2007). In Paratransit, the Court held that creditors may sue a corporation’s directors pursuant to the CBCA if they authorize unlawful distributions (i.e. when the corporation is insolvent), despite the fact that the CBCA, on its face, seems only to allow for recovery of improper shareholder distributions by the corporation and not by third party creditors. The CBCA was relevant here because it is drafted similarly to Colorado’s Limited Liability Company Act and thus presents the same issue raised in Colborne. In relying on Paratransit, the Colborne Court held that the policy considerations for allowing creditors to sue directors if they authorize unlawful distributions are the same for a corporation as they are for an LLC. Thus the Court extended to creditors of an LLC the same protections that creditors of a corporation have under the Paratransit decision.
What is interesting about Colborne and Paratransit is that in each case, based on policy considerations, the Court significantly expanded rights to creditors that clearly do not exist on the face of the applicable statute. Colborne represents a considerable expansion of creditor’s rights against LLCs. Although many states have laws similar to Colorado’s Limited Liability Act, none have interpreted these laws to permit creditors, in addition to the LLC itself, to directly sue the members of an LLC who knowingly receive unlawful distributions. One could argue that this outcome represents judicial activism and that it is only within the purview of the Colorado Legislature to create such rights.
On August 16, 2010, the Colorado Supreme Court granted certiorari, ostensibly to finally make clear whether creditors can maintain claims directly against individual members of an insolvent LLC under the Act. See Weinstein v. Colborne Corp., 2010 WL 3213046 (Colo. Aug. 16, 2010). It will be interesting to see what the Supreme Court does with this case. Stay tuned.