California Court Holds That Individual Members of an LLC Can Be Personally Liable for Debts of a Dissolved LLC Under Certain Conditions

The case of CB Richard Ellis, Inc. v. Terra Nostra Consultants has important implications for anyone seeking to collect on a judgment against the individual members of an LLC that has no assets, that has been dissolved, and that was unable to pay the debt as a result of failing to set aside sufficient funds to pay creditors.

In CB Richard Ellis, Defendant Jefferson 38, LLC (“Jefferson”) sought a buyer for 38 acres of land in Murrieta, California. To this end, in March of 2004 Jefferson signed an exclusive sales listing agreement with Plaintiff CB Richard Ellis, Inc. (CBRE). Under the agreement, Jefferson agreed to pay CBRE a sales commission of 6 percent of the gross sales price for any sale completed within the term of the listing agreement.

Eventually, a buyer contacted Jefferson. Normally, any commission to the listing agent is paid out of the escrow funds, and there is no problem. However, according to the court’s recitation of the facts of this case, Jefferson, in spite of its agreement with CBRE, excluded CBRE from its sale of the property. Sometime around September 2004, a representative of Jefferson told a potential buyer, Covenant Development, Inc. (“Covenant”), that Jefferson had fired CBRE because Jefferson was dissatisfied with CBRE’s performance. Moreover, Jefferson took the position that it did not owe CBRE a commission because the listing agreement had expired in September 2004, well before the sale was completed.

On July 11, 2005, escrow closed on Jefferson’s sale of the property to an entity to which Covenant had assigned its interests for a gross sales price of $11,800,000. As the court explains, “On July 12, 2005, $11,025,625 was transferred into Jefferson’s bank account as a result of the close of escrow. The next day, Jefferson transferred all but $474.45 out of its account. This money was ultimately transferred in varying amounts to defendants and others.” The commission for the sale was split between NAI Capital (the buyer’s agent) and L. James Grattan & Associates (Jefferson’s agent). CBRE received no commission.

In July 2005, pursuant to an arbitration clause in the listing agreement, CBRE brought an arbitration claim against Jefferson. CBRE was awarded $960,649.30, which included the 6 percent commission, pre-award interest, and attorney fees and costs. The Los Angeles Superior Court confirmed the award and a  judgment for $985,439.80. However, by this time, Jefferson had no assets and was unable to pay CBRE. Eventually, the LLC was dissolved.

In June 2008, CBRE filed a complaint for breach of contract and prohibited distributions against the four (former) individual members of Jefferson. A jury trial began in 2011. The jury ultimately found that Jefferson had failed to perform under the agreement, that Jefferson had been dissolved, and that Jefferson had made a distribution to the members upon dissolution. The court entered judgment against the defendants for $354,000.

Defendants appealed the judgment, claiming, among other things, that the trial court had improperly instructed the jury regarding dissolution of the company, an issue that hinged partly on interpretation of the California statutes governing LLCs. However, the court rejected this and other arguments, found that the jury had been correctly instructed, and upheld the trial court’s judgment.

Generally, the individual members of an LLC are not liable for the debts, obligations, or judgments of the company. Indeed, as the name implies, the whole point of forming a limited liability company is to protect its members from personal liability. Nevertheless, there are exceptions to this rule. As the court explained, “Part of CBRE’s case involved proving Jefferson was a dissolved limited liability company, which lacked the ability to pay CBRE as a result of its distribution of assets to its members without reserving sufficient funds to pay CBRE.” With respect to its interpretation of California’s LLC law, the court further explained,

It is self-evident that former section 17355, subdivision (a)(1), was designed to prevent the unjust enrichment of members of limited liability companies, when such members have received assets the dissolved company needs to pay creditors. (See Gottlieb v. Kest (2006) 141 Cal.App.4th 110, 154 [former § 17355 “simply creates an enforcement mechanism so that company liabilities can be recovered out of distributed assets; it ‘compel[s] [a member] to return distributed assets’”].) Other sections contemplated that limited liability companies will not distribute funds to members without reserving sufficient assets to pay debts and liabilities. (Former §§ 17254, 17353.) If defendants’ interpretation of the statutory scheme were correct, companies (and their members) could avoid the force of former section 17355, subdivision (a)(1)(B), by the simple expedient of transferring assets out of the company the day before voting to dissolve.

In other words, even though LLCs are intended to limit liability against individual members, it would be unjust to allow members to dissolve their company and divert funds to themselves that should have been set aside to pay a creditor to satisfy a company debt. This case is important because it appears to be the first published opinion that involves a plaintiff getting a judgment against individual members of an LLC. It sends a clear message that the California courts are not willing to let individual LLC members abuse the LLC system in order to enrich themselves personally.

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