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Colorado and Denver LLC Attorney and Limited Liability Company Attorney
A limited liability company (“LLC”) is a legal entity separate and distinct from its owners that is primarily used to engage in business ventures while protecting those investing in the business or running the business from personal liability. There are significant nuances to limited liability companies. Accordingly, when dealing with LLC issues, searching for a Colorado and Denver LLC attorney near me or a Denver and Colorado LLC lawyer near me can help one find an attorney and obtain legal advice to resolve those issues. For example:
• A Colorado and Denver limited liability company lawyer can help with the formation of an LLC
• A Denver and Colorado LLC lawyer can explain and help one navigate Colorado’s limited liability company statutes
• A Colorado and Denver limited liability company attorney can explain and help one navigate Colorado’s LLC operating agreement requirements
• A Denver and Colorado LLC attorney can help assess duties that LLC managers owe to the company
• A Colorado and Denver limited liability company lawyer can help assess duties that members of a limited liability companies owe to the company
• A Denver and Colorado LLC lawyer can help assess if a member or manager has breached any duties owed to the company
• A Colorado and Denver limited liability company attorney can help assess legal actions members or managers may have against each other
• A Denver and Colorado LLC attorney can help assess legal actions that members or manager may have against the company
• A Colorado and Denver limited liability company lawyer can help determine appropriate routes for bringing direct lawsuits against a limited liability company or its members or managers
• A Denver and Colorado LLC lawyer can help determine whether an action involving an LLC must be brought as a derivative action
• And, a Colorado and Denver limited liability attorney can help with litigating and defending lawsuits in court that involve limited liability company rights
If you are dealing with LLC legal issues, J.D. Porter, LLC offers excellent legal services at fair rates. The firm uses a modern, lean and light business structure to reduce overhead and democratize access to legal services. This results in the firm being able to dedicate more time and energy to a particular client’s case resulting in better outcomes for the client. This post discusses many legal aspects relating to forming LLCs and legal implications in running and governing Limited Liability Companies.
A Denver and Colorado LLC Attorney Can Help Navigate Colorado’s Limited Liability Company Statutes and Assist with the Formation of an LLC
Colorado limited liability companies are governed by the Colorado Limited Liability Company Act, C.R.S. §§ 7-80-101, et seq. The act covers a variety of basic aspects of LLCs such as formation, governance, ownership, transfers of ownership, and dissolution.
Under the act, a limited liability company is formed by filing articles of organization with the Colorado Secretary of State. Articles of organization are, in sum, a bare bones document containing basic information about the LLC such as its name, whether the LLC is member-managed or manager-managed, the business address of the LLC, the registered agent of the LLC, and the name of the individual making the filing. The person filing the articles of organization does not have to be a member of the limited liability company and only has to be over 18 years old. Accordingly, representatives or agents of the LLC may file articles of organization on behalf of the company. See C.R.S. §§ 7-80-203, -204.
Importantly, the articles of organization for a limited liability company are separate and distinct from the operating agreement of the LLC. The articles of organization indicate the LLC is in existence in Colorado Secretary of State records and contain basic information about the limited liability company, such as designating a registered agent in case somebody needs to contact the company or serve the company with a lawsuit. In contrast, the operating agreement for an LLC governs the internal working and ownership of the limited liability company; sets forth member and manager rights, to the extent there are any managers; and is typically a private document that is filed with the Colorado Secretary of State. While the filing of the articles of organization is the technical legal act that forms the limited liability company, the operating agreement can be drafted or otherwise entered into before the LLC is formed. See C.R.S. § 7-80-108(1)(c). Hiring a Denver and Colorado LLC lawyer can help with the formation of a limited liability company.
A Colorado and Denver Limited Liability Company Attorney Can Help Draft and Explain an LLC Operating Agreement
At its simplest, a limited liability company operating agreement is a contract between those forming the LLC that defines the rights and obligations of the owners, also called “members”; how the company will be run; and the conduct of the company. Because an operating agreement sounds in contract law, the members of an LLC have wide discretion in drafting the operating agreement and defining the rights and obligations therein. Notably, an operating agreement does not necessarily have to be in writing and, instead, can include an oral agreement as to how the company should be run. See C.R.S. §§ 7-80-102(11), -108(5).
For single-member limited liability companies, failure to have a written operating agreement does not necessarily present an issue as, by nature of the LLC having only one owner, all decision-making authority is vested in that one individual. Accordingly, there is usually no one else to dispute how that individual chooses to run the company and, thus, having the rights and obligations of that member reduced to writing has minimal benefit.
However, for multi-member LLCs it is wise to reduce the operating agreement to writing so that the rights and obligations of the members and how the company will conduct business is memorialized in a referenceable document. While business ventures are often created with the best of intentions, relationships can sour quickly and, if legal issues arise, it can be hard to establish somebody is violating an operating agreement where there is no written documentation that concretely defines a member’s or manager’s rights and obligations.
The Colorado Limited Liability Company Act provides some basic provisions as to how LLCs should function. However, and with some restrictions, members of an LLC are free to vary those provisions by the operating agreement. In other words, except for some narrow provisions in the Colorado Limited Liability Company Act that cannot be varied, to the extent an operating agreement differs from statutory provisions the operating agreement will govern. If there is no operating agreement at all, then the provisions of the Colorado Limited Liability Company Act will govern. See C.R.S. § 7-80-108(1)(a).
In general, an operating agreement will typically:
• Specify who the members of the limited liability company are, their respective ownership interest in the company on a percentage basis, and the capital contributions each member made to the company.
• Specify how members may transfer or sell their interests. Importantly, since LLCs are frequently closely held companies, members have an interest in ensuring ownership remains with those they trust and want to be in business with. Accordingly, to protect these interests many operating agreements contain approval provisions requiring the consent of other members before a member may sell or transfer their interest to another person.
• Designate who has authority to act on behalf of and run the limited liability company. This includes indicating whether the LLC will be member-managed, meaning the members are in charge of the day-to-day activities of running the company; or manager-managed, meaning the members delegate their authority to one or more “mangers” of the company who are in charge of running the company.
• Address what fiduciary obligations members and, if applicable, any managers owe to the limited liability company. This includes typical fiduciary obligations such as a duty of good faith and fair dealing, a duty of loyalty, a duty of care, and a duty not to usurp corporate opportunities.
• Address how additional capital contributions will be made to the LLC, including how capital calls can be made, who has authority to make capital calls on behalf of the company, whether members are required to comply with capital calls or may decline to contribute additional capital, and what happens if capital call contributions are not made.
• And, contain provisions addressing dissolution of the company, including triggering events for dissolution, who is in charge of dissolving the company once a triggering event occurs, how assets and liabilities will be accounted for in the wind-up process, and how any residual assets will be distributed amongst the members after the wind-up process is complete.
While there an infinite number of ways that an LLC can be structured and, thus, an infinite number of ways the above aspects can be addressed, there are some aspects of limited liability companies that, by statute, cannot be altered by the operating agreement. In particular, and pursuant to C.R.S. § 7-80-108:
• An operating agreement may not unreasonably restrict the rights of members and managers to access or be provided company information as provided in C.R.S. § 7-80-408. This includes the ability to ask for specific documents from the company, the right to full and accurate business and financial information of the company, and the right to access any other information that is just and reasonable.
• An operating agreement may not eliminate the contractual obligation of good faith and fair dealing that members and managers owe to the company and to each other under C.R.S. § 7-80-404(3). However, the operating agreement may narrow the obligation by prescribing standards against which the obligation is to be measured, provided those standards are not unreasonable. The obligation of good faith and fair dealing is, in simple terms, the idea that members and managers will exercise their rights and obligations for legitimate and purposeful reasons as opposed to exercising them in bad faith or to harass and annoy other members or managers associated with the company.
• An operating agreement may not eliminate the dissolution provisions of C.R.S. § 7-80-801(1)(c)(I) which provide for the dissolution of an LLC in certain circumstances, including where the limited liability company ceases to have any members.
• And, an operating agreement may not vary any requirement under the Colorado Limited Liability Company Act that mandates a particular action or provision under the act be reflected in writing.
Accordingly, while almost all of the default relationships and obligations that come with formation of an LLC are variable through defining or limiting them in the operating agreement; the duties and obligations that are most central to engaging in a business venture, such as providing appropriate documents and dealing with each other in good faith, are not variable under the Colorado Limited Liability Act. Retaining a Colorado and Denver LLC lawyer can help assess what duties can be waived in an operating agreement and what duties cannot.
A Denver and Colorado Limited Liability Company Attorney Can Help Explain and Research Whether the Offering of LLC Membership Interests Constitutes a Security Subject to Regulations
Due to the risky nature of investing, there are many regulations intended to govern such activities. In particular, federal and state securities laws are typically broadly written and may be applicable to the sale of limited liability company ownership interests. In general, if an investment offering qualifies as a security under federal or state regulation schemes, then they are typically subject to registration unless they fall under a particular exemption. The federal Securities Act of 1933, 15 U.S.C. § 77a, et seq., and the Colorado Securities Act, C.R.S. § 11-51-101, et seq., are examples of security regulation schemes that would apply to the sale of securities in Colorado.
Investment regulatory schemes are typically broadly written as they are meant to protect the public and soliciting investments can come in many different forms. By way of example, the federal Securities Act of 1933 defines a “security” as:
any note, stock, treasury stock, security future, security-based swap, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or, in general, any interest or instrument commonly known as a “security”, or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing.
See 15 U.S.C. § 77b. The definition of “security” in the Colorado Securities Act mirrors that of the federal Securities Act of 1933 almost word for word and reflects the breadth of what the securities regulatory schemes were designed to cover. See C.R.S. § 11-51-201(17).
Importantly, and as pertinent to the sale of LLC ownership interests, both the federal Securities Act of 1933 and the Colorado Securities Act both explicitly include “investment contracts” within their definitions of security. While this definition also has ambiguity, in the seminal case Securities and Exchange Commission v. Howey Co., 328 U.S. 293 (1946), the U.S. Supreme Court gave guidance on the breadth of what qualifies as a security and interpreted the phrase “investment contract” to mean:
a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party
The specific issue in Securities and Exchange Commission v. Howey Co. was whether the sale of small parcels of land on an orchard, coupled with service contracts for servicing the orchard, constituted securities under the federal Securities Act of 1933. If they did qualify as security, there were subject to registration, which had not occurred, and therefore were being sold in violation of the federal securities regulations.
The U.S. Supreme Court, looked to the breadth of the definition of “security”, and looked to how other states had defined that term in their own security regulations, and found that the land sale and service contracts constituted investment contracts because, at their core, the contracts constituted a way for individuals to contribute money and share in the profits of a large, fruit harvesting enterprise while having minimal to no involvement in how the enterprise was run.
That is, those purchasing the contracts were investing money into a common enterprise with the expectation of profits. And, the production of those profits was solely dependent upon the efforts of the third-party company running the fruit harvesting enterprise, not those purchasing the orchard land. Accordingly, the U.S. Supreme Court found the contracts were investment contracts and, as a result, qualified as securities under the federal Securities Act of 1933.
The implication of this for LLCs is that where membership or ownership interests of a limited liability company are being sold to raise funds for the LLC, and those buying those interests have no management role in the company, the sale of those membership interests is likely an investment contract that qualifies as a security under both the federal Securities Act of 1933 and the Colorado Securities Act. In practical terms, this means that only where those putting money into the company also have an active role in the management of the company is it unlikely that those membership interests will not qualify as securities.
Importantly though, even where the sale of a limited liability company membership interest qualifies as a security under the federal Securities Act of 1933 and the Colorado Securities Act, there are numerous exemptions where the sale of those securities does not have to be registered. Some common exemptions are the private placement exemption under 15 U.S.C. § 77d(a)(2); the intrastate offering exemption under 15 U.S.C. § 77c(11) for securities sold only to persons within a single state; and the accredited investor exemption under 15 U.S.C. § 77d(a)(2) where the securities are only offered to specified types of financial institutions and individual investors with a high enough net worth. Due to the extra time and expense associated with registering securities, to the extent LLC membership interest qualify as a security it is favorable if they fall under an exemption and, therefore, do not have to be registered. Assessing the interplay of limited liability company membership interests and securities’ laws can be a complex task. Accordingly, hiring a Denver and Colorado limited liability company attorney can help navigate these issues.
A Colorado and Denver LLC Lawyer Can Help Explain and Analyze the Management Structure of a Limited Liability Company
As required by Colorado’s Limited Liability Company Act, an LLC must either be member-managed or manager-managed. This selection must be reflected in the company’s publicly filed articles of organization. See C.R.S. § 7-80-204.
The selection of a member-manager or manager-managed company is important as it defines whether the members will run the company or whether the members will select other individuals and delegate authority to those individuals to run the company. Since many limited liability companies are formed as investment vehicles to allow individuals to invest in a business venture without having to be involved in the day-to-day operations of the company, forming a manager-managed LLC is common.
Additionally, forming a manager-managed LLC has benefits of limiting who has authority and agency to act on behalf of and bind the company. In particular, in a manager-managed LLC only the managers, as opposed to the members, are agents of the company and may bind the company in the ordinary course of business. In contrast, for member-managed limited liability companies, each member is an agent of the company and may act on behalf of and bind the company. See C.R.S. § 7-80-405.
Agency and the ability to bind an LLC is an important concern, especially when dealing with third-parties. Because third-parties are generally not privy to the internal workings or internal structure of a limited liability company, an individual purporting to act on behalf of an LLC, even where that individual does not have actual authority to do so pursuant to the company’s operating documents, may still bind the limited liability company in certain circumstances. This is particularly so where the company took actions to suggest that person has authority to bind the company and the third-party had no notice otherwise. See C.R.S. § 7-80-405. Accordingly, properly delegating manager or member authority is an important consideration in structuring an LLC.
As provided by statute, and where there is no operating agreement specifying otherwise, the default decision making structure for a limited liability company requires the majority consent of the members or managers, depending on whether it is a member-manager or manager-managed company, in order to make business decisions on behalf of the LLC. Additionally, the statute includes a heightened, unanimous consent of all members requirements to amend the articles of organization, amend the operating agreement, and for the company to take actions that are not in the ordinary course of business. See C.R.S. § 7-80-401. Depending on the structure and nature of the business, using this default structure can be extremely cumbersome. For example, if essentially every business decision requires a vote of all members or managers of the company, even the most basic daily business operations for the company can become bogged down. Retaining a Colorado and Denver LLC attorney can help assess member and manager structure and who has authority and agency to act on behalf of the company.
A Denver and Colorado Limited Liability Company Lawyer Can Help Explain and Analyze the Duties Members and Managers Owe To an LLC
Those in charge of the company, be it members or managers of the company, owe certain duties to the company. In particular, C.R.S. § 7-80-404 outlines those default duties, many of which can be changed, narrowed, or eliminated by the operating agreement.
In particular, the C.R.S. § 7-80-404 provides that each member of a member-managed LLC and each manager of a manager-managed LLC owes a duty to the company to:
• Account to the LLC. In essence, this means that those in charge of running the company must keep track of the financials of the company, including company expenditures; the assets of the company; and the liabilities of the company. Notably, the statute doesn’t define what constitutes an “accounting” and, thus, a professional accounting may not necessarily be required. Instead, providing sufficiently detailed documentation to indicate the financial condition of the company will likely suffice.
• Refrain from usurping any company opportunities; refrain from competing with the company; and account to the company for any property, profit, or benefit personally received or taken from the company. In other words, members and managers have a duty of loyalty to the company. In simple terms, this is the requirement that they should not do things to harm the company, compete with the company, take business opportunities the company has for the member or manager’s own personal benefit, or otherwise take property from the business without company approval.
• Fulfill their duty of care in the conduct and winding up of the company. This is the requirement that those in charge of running the company shall not engage in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of the law in running the company and winding up the company.
• Fulfill their duty of good faith and fair dealing. As discussed above, this means that members and managers must exercise their rights and obligations in good faith. They shall not seek to actively undermine the company or otherwise exercise their rights and obligations solely to harass and annoy one another. Notably, however, it is not a breach of this duty for a member or manager to exercise their rights and obligations in a manner that furthers their own interests. For example, a member may request comprehensive documents from the company so that the manager can assess the company’s financial position in detail. The request might be burdensome and those in charge of the company might see it as harassing or annoying; but, the member has a strong interest in ensuring their investment is protected and, accordingly, asking for those documents is not a breach of the duty of good faith and fair dealing.
Importantly, and subject to the restrictions on altering duties in C.R.S. § 7-80-108 discussed above, most of these duties and rights can be altered and, in some cases, entirely eliminated by the operating agreement. For example, the duty of loyalty is often altered or eliminated in an operating agreement to allow members and, if applicable, managers to engage in competing business opportunities. This can allow individuals to invest in one company while at the same time pursuing opportunities with other companies that are in an overlapping business sector. Or, for managers, allow them to run an existing company while at the same pursuing other opportunities in a similar sector. Hiring a Colorado and Denver limited liability company can help assess these duties and what duties can properly be restricted or waived.
A Colorado and Denver LLC Lawyer Can Help Assess and Litigate Breach of Fiduciary Lawsuits Against Members and Managers
Where a member or manager owes fiduciary duties to the LLC or other members or managers of the LLC and breaches those duties, then a breach of fiduciary claim may be brought against the breaching party. In particular, under Colorado law a breach of fiduciary duty claim requires the following elements to be proven:
(1) The defendant was acting as a fiduciary of the plaintiff
(2) The defendant breached a fiduciary duty owed to the plaintiff
(3) The plaintiff incurred damages
(4) And, those damages were incurred as a result of the defendant’s breach
See Spacek v. Taylor, 381 P.3d 428 (Colo. App. 2016). Notably, while the duties of care and loyalty discussed above are traditional fiduciary duties, the duty of good faith and fair dealing stems from principles of contract law, not fiduciary principles. However, from a practical perspective and in the context of LLCs, the difference between a contractual duty and fiduciary duty is likely a distinction without a difference. Accordingly, courts may interpret the duty of good faith and fair dealing as a fiduciary duty similar to the duty of care and duty of loyalty obligations.
Some examples of Colorado cases interpreting and involving breach of fiduciary claims with limited liability companies include:
• Mcwhinney Centerra Lifestyle Ctr. LLC v. Poag & McEwen Lifestyle Ctrs.-Centerra LLC, 486 P.3d 439 (Colo. App. 2021): Where two companies sought to develop a shopping center and created an LLC to do so with each company being the LLC’s respective members. When the shopping center project failed, the plaintiff company brought suit against the defendant company alleging, among other things, that the defendant company had breached its fiduciary duties as a member and manager by entering into interest rate swaps and obtaining a mezzanine loan to further its own interests. In particular, the swaps and mezzanine loan were entered by the defendant companies to buy out one of its partners and, as the evidence entered at trial showed, the swaps and mezzanine loan were risky and gave the counter-party bank significant authority over management of the shopping center project. In response, the defendant company asserted that the shopping center project’s LLC operating agreement waived the defendant company’s duties of care and loyalty and, thus, it could not be liable for breach of fiduciary duties. The Colorado Court of Appeals looked to Delaware law, as that was the governing law specified in the operating agreement, and found that, in order for there to be a waiver of the fiduciary duties of care and loyalty the waiver language in the operating agreement needed to be explicit which, in this case, it was not. Additionally, the operating agreement also specifically included a duty of fair dealing between the members. Accordingly, the Court of Appeals affirmed that the defendant company owed fiduciary duties of care and loyalty to both the shopping center project LLC and the other member company, and a duty of fair dealing to the other member company and affirmed that the interest rate swaps and mezzanine loan constituted a breach of those duties.
• Denver Inv. Advisors, LLC v. St. Paul Mercury Ins. Co. (D. Colo. 2017): A case involving insurance indemnification issues where retired members of an LLC had sued the current members of the LLC for improperly taking distributions that reduced earnout payments to the retired LLC members. The retired members brought, among other things, claims of breach of fiduciary duty against the current members for those improper distributions. In assessing whether the breach of fiduciary duty claims sounded in tort or contract and, therefore, where or not they were barred by the economic loss rule, the Colorado federal district court noted that, pursuant to Colorado’s Limited Liability Company Act, there are no statutory fiduciary duties owed to retired members of an LLC. The court still found there were fiduciary duties owed to the retired LLC members; however, those fiduciary duties came from contractual provisions in the operating agreement as opposed to Colorado’s statutes. Specifically, the court looked to the operating agreement which contained provisions governing the compensation owed to retiring members and, accordingly found those provisions implicated fiduciary duties to the retired LLC members. Therefore, the district court found that because the fiduciary duty claims sounded in contract as opposed to common law or statute, those claims fell under contractual exclusion provisions in the management indemnity insurance agreement that was at issue in the case. As a result, because those claims fell under the insurance exclusion provision, the insurance company was not required to advance money to pay for the defense of the current LLC members against those claims.
• Long v. Cordain, 343 P.3d 1061 (Colo. App. 2014): Where two people formed an LLC to promote a paleo diet program that one of them had developed and sought to develop as a business. Th person that had developed the program granted the LLC an exclusive license to use the paleo diet information as well as that person’s related research. The two people eventually had a falling out and the individual that had developed the program dissolved the LLC, formed a new limited liability company, and began engaging in a competing business. The other individual then sued asserting the individual that had developed the program had breached his fiduciary duties of good faith and loyalty owed to the other member by engaging in promotional activities on behalf of the new company. Specifically, the individual alleged such conduct constituted self-dealing and usurpation of the original LLC’s business opportunities. In resolving a federal court versus state court jurisdictional issue, the Court of Appeals found the breach of fiduciary claim was a state law claim and, therefore, could proceed in state court.
• Weinstein v. Colborne Foodbotics, LLC., 302 P.3d 263 (Colo. 2013): Where a creditor obtained a judgment against an LLC and, after a distribution had been made from the LLC to its members rendering the LLC insolvent, the creditor brought sought against those members asserting, among other things, that the LLC’s managers had violated a fiduciary duty in the winding up process not to put their own interests above those of the LLC’s creditors. The Colorado Supreme Court looked to the plain language of the Colorado Limited Liability Company Acy and held that the managers did not owe fiduciary duties to the creditor and, therefore, the managers could not be directly sued by the creditor. Instead, the creditor’s claims were against the LLC and, to the extent the creditor prevailed, it may have alter ego or piercing the corporate veil claims against the managers but the creditor did not have direct breach of fiduciary duty claims against the managers.
Notably, due to the inherent ambiguity of fiduciary duties, navigating and litigating a breach of fiduciary duty claim can be complex. Since particular fiduciary duties and the scope of those duties can be narrowed, specifically defined, or entirely eliminated in the LLC operating agreement, determining if a member or manager has breached those duties can be a nuanced and difficult analysis. For example, a member or manager may be prohibited by the operating agreement and the duty of loyalty from engaging in competing businesses; however, it can be a grey area as to whether or not engaging in a business tangentially related to the LLC’s business is a competing business and, therefore, a breach of that duty. Accordingly, hiring a Denver and Colorado limited liability company can help navigate and assess breach of fiduciary duty claims.
A Denver and Colorado Limited Liability Company Attorney Can Help Determine if a Lawsuit Involving an LLC Must Be Brought as a Derivative Action
Because of the structure of limited liability companies and the fact that there is typically distributed authority as to who is in charge of running the LLC, where there is an issue involving the limited liability company – including disputes between members and managers as to whether the company is being properly run – simply determining who can sue, the parties to sue, and how to sue can be a complex task.
For external disputes, which are those between the LLC and a third-party, these issues are typically much simpler. For example, if the limited liability company owes money to a third-party, that third-party would simply sue the LLC itself. It is a third-party claim against the LLC and, unless there are authority or agency issues with the LLC involved, such a claim would likely not involve having to figure out the inner workings of the LLC or who has the right to bring the claim against the LLC.
In contrast, for internal disputes, which most commonly involve a dispute as to how the LLC is being run or whether or not those in charge of the company should pursue claims the LLC has against another party, there can be special procedures that apply and must be followed before certain lawsuit may be brought. This is particularly true where the limited liability company has or may have a claim against another party, those in charge of running the LLC are not pursuing the claim, and a member of the LLC thinks the company should pursue the claim and wants to force the company to do so.
These special types of lawsuits, where a member is looking to force the company to pursue a claim, are called derivative actions and, in simple terms, allow a member to stand in the shoes of the limited liability company and bring a lawsuit on behalf of the company where those in charge of running the LLC have failed or refuse to do so. Derivative actions are nuanced and, if not properly brought or the unique derivative action procedures not properly followed, the action may be dismissed by the presiding court.
The Colorado Limited Liability Company Act contains specific provisions governing derivative actions. C.R.S. § 7-80-713 governs who has the right to bring a derivative action and provides that only members who had a membership interest at the time the action complained of accrued or later received a membership interest through operation of law, such as the beneficiary of a member’s interest when that member passes away, has the right to bring a derivative action. Additionally, the statute requires that the member bringing a derivative action must be sufficiently situated that the member fairly and adequately represents the interests of other similarly situated members.
Putting these requirements together and in more simpler terms, the statute requires that, in order to have standing to bring a derivative action, a member must have had or received by operation of law a membership interest that was injured by the act complained of and that member must be sufficiently unbiased or independent from the affairs of the company that the member will adequately represent the interests of other, unbiased and similarly situated members in enforcing the rights of the LLC.
Furthermore, if a member meets these requirements and wants to bring a derivative action, the member must, with a few exceptions, give notice to the limited liability company of the claim the member wants to pursue before filing that derivative action. Specifically, C.R.S. § 7-80-714 governs these notice requirements and provides that no member shall commence a derivative proceeding unless a written demand has been made to the LLC demanding the company take suitable action and either 30 days have elapsed and the company has taken no action, or the member was notified by the limited liability company that it will not be pursuing the claim.
Importantly though, the statute provides a few narrow exceptions where a demand is not necessary allowing a member to promptly file a derivative action without first providing notice. One of these exceptions is where giving notice and waiting for the 30 day period, or waiting for a response from the LLC would cause irreparable injury to the company. Accordingly, the statutes authorize a derivative action to be promptly filed. Notably, while there exists a futility exception for corporations – meaning a demand is unnecessary where the shareholder can show it would be futile to make a demand as the corporation would certainly decline to pursue the claim – no futility exemption exists under Colorado’s statutes for LLCs. See Ramos v. Whole Hemp Co., No. 19-CV-03268-CMA-KMT (D. Colo. 2020). Accordingly, even if making a demand would be futile for an LLC member because it would clearly be denied, the member should still make that demand to comply with statutory requirements.
Importantly, after making the demand or, if a derivative action has already been filed, while the action is pending, the limited liability company may investigate the claims asserted and make a determination as to whether or not it is in the best interests of the LLC to pursue them. If sufficiently unbiased and independent people are the ones assessing and making that determination on behalf of the LLC, and they determine it is not in the best interests of the company to pursue those claims, the LLC can then prevent derivative actions for those claims by dismissing them upon motion to a presiding court.
The independent individuals designated to review the derivative action claims are commonly called “Special Litigation Committees.” The idea is that certain claims may not be worth the company pursuing and, accordingly, if unbiased individuals look at the claim and determine it is not in the best interest of the company to pursue then that assessment will bind the company and members cannot override it. On the other hand, if the LLC receives a demand, reviews it, and determines it will pursue the claim then no derivative action is necessary. Those in charge of the limited liability company will simply have the LLC file a lawsuit on its own behalf to pursue the claim.
With respect to Special Litigation Committees and reviewing derivative action demands, a critical aspect is that those investigating the claim and determining if it is in the best interests of the LLC to pursue or not must be sufficiently disinterested, or “independent” from the subject matter of the claim. This requirement is important as it protects against potential conflicts of interest where, for example, the asserted claim involves the LLC pursuing a lawsuit against somebody involved with or managing the LLC. In such circumstances, if there were no requirement the individuals investigating the claim be disinterested from the claim itself, it could result in a scenario where an individual is in charge of deciding whether the LLC should sue himself, a clear conflict of interest.
Notably, where a derivative action demand is made and the LLC investigates and determines it is not in the best interest of the company to pursue, a member may refute the LLC’s finding by demonstrating that the investigation was not sufficient or those in charge of making the decision were not sufficiently independent as to render an unbiased decision. Accordingly, even where an LLC purports to have completed its investigation and seeks to dismiss a derivative action, the plaintiff still has routes to refute the LLC’s finding and potentially continue with the derivative action if a court finds the company’s investigation was defective in some manner. See C.R.S. 7-80-716.
While actually bringing a derivative action has its own unique procedures and requirements, an additional nuance to dealing with derivative actions is whether or not the claims are actually derivative in the first place. This can be particularly relevant where the issues involve claims between members and managers of the company. It can be hard to parse out whether the claim is actually a claim that the company has and, therefore, is derivative; or, if by relation of the duties owed between members and managers, the claim is a direct one between members or managers themselves.
For example, if a member contends a manager mismanaged the company, breached the manager’s fiduciary duties to the company, and wasted company assets or funds, it can quickly become blurred as to whether it was the member that was injured or the company that was injured, or both.
In determining whether a claim is derivative or direct, Colorado courts look to:
(1) Who suffered the alleged harm
(2) And, who would receive the benefit of any remedy
See Young v. Bush, 277 P.3d 916 (Colo. App. 2012). Along these same lines, a claim is direct – meaning it is direct between the parties and not a derivative claim on behalf of the LLC – where the member suffered injuries separate and distinct from the injury to the LLC generally. That is, if the harm is generalized to the LLC and all of its members then it likely is a derivative action. In contrast, if a member was uniquely harmed by another member or manager as opposed to that member or manager generally harming the limited liability company, then it is likely a direct action and the derivative action procedures do not apply.
For example, if a manager’s breach of duties generally caused harm to the limited liability company by dissipating the LLC’s assets; then, although each individual member may have been harmed through reduction of their equity, the injury is still general to the LLC. That is, the limited liability company suffered the harm even though it flowed through to each member. Similarly, if the manager were to be sued for breach of those fiduciary duties, recovery of damages would go to replenish the funds of the LLC generally. Members might benefit from the flow-through of that recovery but the money would still be the LLC’s money. Accordingly, these types of claims are likely derivative actions.
In contrast, if the manager, for example, made specific representations to one of the members in order to get that member to invest in the LLC and those representations later turned out to be fraudulent, the member would likely have a direct action against the manager. The member relied on those specific representations; suffered a separate and distinct injury from the LLC in the sense that the manager’s fraud impacted that member directly in the forming of inducing the member to invest; and, if any remedy is obtained against the manger, it would flow directly to the member as reimbursement for his investment. Accordingly, a claim of this type would likely be a direct claim the member could bring against the manager and would not have to go through the derivative process.
Parsing out whether a claim is direct or derivative can be a factually intensive and nuanced process, especially where the limited liability company is a closely held company and there are only a few members that are also in charge of running the company. Accordingly, hiring a Denver and Colorado limited liability company attorney can significantly help in parsing out these issues.
A Colorado and Denver LLC Lawyer Can Help Explain and Navigate the Dissolution of a Limited Liability Company
Aside from forming a limited liability company, running a limited liability company, and dealing with lawsuits on behalf of the limited liability company, the next main legal considerations in dealing with limited liability companies are dissolving it. Dissolution of an LLC is the process of terminating the company, winding up the company and making final distributions, and making public filings indicating that the company no longer exists. The winding up and dissolution process includes performing a final accounting of the LLC’s assets and liabilities, providing notices to creditors to make any final claims against the LLC before those claims are discharged, distributing any remaining assets of the LLC to its members after those claims periods have run, and making filings with the Colorado Secretary of State indicating the company has been dissolved.
While there are many reasons why an LLC may be dissolved, in general, dissolution occurs where there is no point to maintaining the limited liability company as an ongoing entity anymore. This may occur because the purpose of forming the LLC has been completed; the members of the limited liability company no longer get along and want to terminate the relationship; or where an LLC is simply no longer profitable and there is no point to continue operating it as a business.
Regardless of the reasons, the dissolution process is important in ensuring that liability for the company remains insulated to the LLC entity and does not extend to its members. If the dissolution process is performed improperly and improper distributions are made to the LLC’s members, creditors of the LLC could potentially sue to claw back those improper distributions from individual members.
With respect to the dissolution process itself, pursuant to C.R.S. § 7-80-801 dissolution of a limited liability company can be triggered in a variety of ways. Dissolution can occur upon the agreement of all members to dissolve the LLC, can be triggered when dissolution events specified in the operating agreement occur, or can occur when the LLC ceases to have any members.
Upon the occurrence of a dissolution event, the limited liability company is required to file with the Colorado Secretary of State a statement of dissolution indicating that the company has been dissolved. Pursuant to statute, 90 days after the statement of dissolution is filed the public is considered on notice that the company is no longer an ongoing business entity. See C.R.S. § 7-80-802.
This imputed public notice aspect is important for agency and third-party claims issues. For example, if after the 90 day period has run somebody tries to sign a new contract on behalf of the LLC without proper authorization and outside of the scope of winding up the company’s business affairs, the contract can be invalidated and found non-binding on the company. In effect, the filing of the statement of dissolution puts the public on notice that it should be cautious in dealing with the company as it is no longer an ongoing business. It also protects the LLC from having those running the company improperly continue to increase the LLC’s liabilities when there is no point to doing so since the company is being wound down.
Accordingly, those dealing with a dissolved limited liability company should take heightened measures to ensure the people they are dealing with actually have authority to bind the company and that the proposed actions are within the scope of dissolving the LLC. Failure to do so could result in having an unenforceable contract with a limited liability company and having to chase after money or reimbursement from the individual that entered into the contract with you.
Notably, with respect to the scope of authority a dissolved limited liability has to transact business, C.R.S. § 7-80-803 limits this authority and explicitly states that a dissolved limited liability company “shall not carry on any business except as appropriate to wind up and liquidate its business.” The statute goes on to give non-exclusive examples of actions that qualify as winding up and liquidating business which include collecting the company’s assets, disposing of business property that will not be distributed to the members, discharging or making provisions for the LLC’s liabilities and third-party claims, and distributing any remaining property amongst the company’s final members.
Notably, Colorado’s Limited Liability Company Act allows members to petition courts for judicial supervision of the dissolution and wind up of an LLC. Having court oversight can be particularly useful where there is acrimony or distrust between the parties and there is an interest in having procedures and mechanisms available to ensure the LLC is properly dissolved. As part of this oversight, the court may appoint a receiver to take actions on behalf of the limited liability company to ensure the dissolution process is managed by an independent and neutral party. See C.R.S. § 7-80-803.3. Members may petition a court for a judicial dissolution and, interestingly, creditors may initiate dissolution of an LLC where they have an established claim against the company and the company is insolvent. See C.R.S. § 7-80-710. Retaining a Colorado and Denver limited liability company attorney can help with the dissolution process.
A Denver and Colorado LLC Lawyer Can Help Explain and Navigate the Dissolution Claims Process for a Limited Liability Company
As mentioned above, one of the most important steps in the dissolution process is properly dissolving the limited liability company so that any liabilities against the company are discharged. A main advantage of an LLC is that its owners are protected from personal liability. Accordingly, dissolving the limited liability company properly maintains that protection and, to the extent the LLC is insolvent or the company has more liabilities than it has assets, any remaining liabilities after distribution of the LLC’s assets will be discharged.
In maintaining the distinction between a member’s personal assets and the LLC’s liabilities in the dissolution process, Colorado’s Limited Liability Company Act provides that a dissolved limited liability company may dispose of claims and liabilities against it in the same way that corporations dispose of their claims under the Colorado Corporations and Associations Act. See C.R.S. § 7-80-803(2) (indicating a limited liability company may dispose of claims against it pursuant to C.R.S §§ 7-90-911 and -912 of the Colorado Corporations and Associations Act).
In general, the claims disposal process under the Colorado Corporations and Associations Act involves providing specific kinds of notice of the LLC’s dissolution to known and unknown creditors of the company. The notice triggers timelines for those creditors to bring suit against the limited liability company to preserve any claims. If claims are not timely brought, then they are discharged pursuant to statute. The practical effect of the claims disposal process is to shorten any applicable statutes of limitations since, where notice is provided, claims must be brought within the claims disposal statute’s time frames as opposed to any normal statute of limitations time frames.
In particular, the limited liability company dissolution claims disposal process under C.R.S. §§ 7-90-911 and -912 provides for two different categories of claims: “known claims” and “unknown claims.” A known claim is one that has solidified or accrued before the effective date of dissolution. Known claims do not include contingent liabilities where some action still needs to occur in order for liability to arise. See C.R.S. § 7-90-911.
An example of a known claim would be where the LLC has failed to pay a bill that was already due and owing before the statement of dissolution was filed. The claim was accrued and known before the LLC dissolution process began. An example of a contingent claim, which does not qualify as a known claim, would be where the limited liability company has some contract to render services to another party at a later date but that date has not run yet. In those circumstances, any liability the LLC owes would be contingent upon the company not fulfilling its obligations under the contract. In short, a known claim is one that has actually accrued and is in existence and known at the time the statement of dissolution was filed.
Pursuant to C.R.S. § 7-90-911, a limited liability company may dispose of known claims in the dissolution process by providing direct notice to the claimant stating that, unless the claim is subject to a shorter statute of limitations, the claim will be discharged if the claimant does not bring an action to enforce the claim within 2 years, or a later date specified by the LLC, after receiving the notice. If the claimant does not commence an action within that time frame, then the claim will be barred.
In addition to disposing of known claims by providing direct notice to the claimant, the Colorado Corporations and Associations Act also provides that all claims, including known and unknown claims, can be discharged by notice of publication in a local newspaper. Notably, since only known claims can be discharged by providing direct notice, unknown claims can only be discharged by newspaper publication.
In particular, C.R.S. § 7-90-912 provides that a dissolved public entity may dispose of all claims against it, whether known or unknown, due or to become due, absolute or contingent, liquidated or unliquidated, based in contract, tort, or any other legal basis, by publishing notice in a newspaper of general circulation in the county where the LLC’s principal office was located or its registered agent’s office was located. The notice must indicate that, unless the claims are barred by a shorter statute of limitations, any and all claims against the company will be barred if not brought within 5 years after the publication of the notice or within 4 months after the claim accrues, whichever is later.
Notice by publication is more comprehensive in the sense that it extinguishes all private claims against the LLC, regardless of whether they have accrued yet and regardless of what legal theory the claim is based on. However, the downside of notice by publication is that it has a longer claims bar time frame. That is, for known claims that are provided direct notice, the time frame to bring a claim can be reduced to 2 years while for notice by publication, the time frame to bring a claim is a minimum of 5 years. Accordingly, while disposition by public notice is broader, there may still be some benefit to providing direct notice for known claims since it shortens the time frame that a claim can be brought.
Where claims are timely brought against the dissolved limited liability company, they may be enforced against the assets of the LLC. Importantly, if assets of the limited liability company were distributed to its members before the claims process has run, then those assets may be clawed back and any properly brought claims may be enforced against those already distributed assets. See C.R.S. § 7-90-913. Accordingly, members of an LLC would be well advised to wait until the claims process has run before taking or receiving any assets from the company.
The claims discharge process is typically the last major step of dissolving the LLC. Once the claims process is complete, a final accounting for the LLC can be done and, if there are any remaining assets in the LLC, those assets can be distributed to the members. If there are only liabilities remaining then those liabilities remain with the LLC and will be discharged upon dissolution or bankruptcy as those liabilities do not carry over to the members of the LLC. See C.R.S. § 7-80-705. Hiring a Denver and Colorado LLC lawyer can help navigate and assess the claims discharge process.
© November 2021 J.D. Porter, LLC