How to Collect – Who Has Contractual Liability?

Many collection matters arise from contract claims.  For example, a signed agreement exists in which Company A agrees to pay $100,000 to Company B.  When Company A defaults on its contractual payment obligation, who can Company B sue to collect?  Often times only the contracting party (Company A) is “on the hook.”  But suppose that Company A is a limited liability company which is owned 100% by an individual, John Smith.  Under what circumstances can Company B sue both the contracting LLC and its individual owner?  The answer to this question has wide-ranging consequences.  Many times the contracting LLC has no assets or is defunct (it is very easy to form and dissolve LLCs).  Pursuing the individual is often the best way to collect.  Unlike an LLC, an individual cannot simply “disappear.”

The individual’s liability depends on whether the individual can be deemed the “alter ego” of the LLC.

To establish “alter ego,” two conditions must be satisfied:

  1. There must be such a “unity of interest and ownership” between the LLC or corporation and its owner that the separate personalities of the LLC and its owner do not in reality exist.
  2. There must be an inequitable result if the liability is deemed to be only the LLC’s.  See F. Hoffman-La Roche v. Superior Court, 130 Cal. App. 4th 782, 796 (2005).

In evaluating the “unity of interest” component, courts commonly apply the following factors:

  • Are funds commingled between the LLC and individual?
  • Are corporate/LLC formalities followed?
  • Is the LLC adequately capitalized?
  • Does the LLC properly maintain minutes and/or corporate records?
  • Are records of the LLC and individual commingled and/or confused?

The mere fact that the individual owns 100% of the LLC is insufficient to warrant an alter ego finding, but can be very significant when coupled with other of the above-described factors.

In evaluating the “inequitable result” component, the general rule is that separateness will not be recognized if to do so would “sanction a fraud or promote injustice.”  See Webber v. Inland Empire Investments, Inc., 74 Cal. App. 4th 884, 900 (1999).

The “alter ego doctrine does not guard every unsatisfied creditor of a corporation but instead affords protection where some conduct amounting to bad faith makes it inequitable for the corporate owner to hide behind the corporate form.”  See Sonora Diamond Corp. v. Superior Court, 83 Cal. App. 4th 523, 539 (2000).  Mere “[d]ifficulty in enforcing a judgment or collecting a debt does not satisfy this standard.”

At the outset of any contract dispute, the creditor should always evaluate alter ego issues to determine the individuals and entities potentially liable for the contractual debt.  Doing so can go a long way towards obtaining a successful resolution.

Leave a Reply

Your email address will not be published. Required fields are marked *

  • Contact The Wallin Firm Now