Many building developers utilize a single purpose entity limited liability company (an “LLC”) to purchase and develop property, such as an apartment complex, a subdivision, or a shopping center. Generally, an LLC’s debts, whether incurred or judicially imposed, belong only to the LLC, not to its members.  However, an LLC’s individual member may be subject to personal liability under the doctrine of alter ego liability if (1) the individual and the LLC share a unity of interest and ownership such that the separate personalities of the two no longer exist, and (2) treating the debts as the LLC’s alone would impose an inequitable result that rewards the bad faith of the individual.  A recent legal decision from Southern California highlights the dangers of disregarding an LLC’s corporate formalities during any construction project.

In 1426 North Laurel Avenue Homeowner’s Ass’n v. Sunset, No. B257815, 2016 Cal. App. Unpub. LEXIS 3875 (Cal. Ct. App. May 26, 2016), developer Sunset on Sunset, LLC (“Sunset”) built a 19-unit condominium at a North Hollywood location.  Sunset had two members, Avraham Hassid and his wife, although as Mr. Hassid’s wife had no involvement with the entity Sunset was operated exclusively by Mr. Hassid himself.  As built and sold to individual owners, the condominium building suffered from unlevel floors that prevented its doors and windows from closing properly and substandard roofing materials and tiles that resulted in catastrophic leaks during rains.  The condominium association sued Sunset and Mr. Hassid, among others, for the cost of repairing the building’s construction defects.  The trial court found Sunset and Mr. Hassid negligent and negligent per se, and awarded the association $4.978 million for the cost of repair, lost use, and the cost of investigation.  Importantly, the trial court held Mr. Hassid jointly and severally liable for the full $4.978 million judgment, finding he was the alter ego of the LLC and therefore personally liable.

The appellate court concluded there was substantial evidence to support the trial court’s alter ego finding and affirmed the ruling. First, the evidence showed Mr. Hassid and the LLC shared a unity of interest and ownership because the LLC was “‘undercapitalized; was operated without respect for its separate entity existence; some of its expenses were paid by other entities; its assets were used to pay liabilities of [Hassid’s] other businesses…; and he “loaned” [the LLC] funds when and as needed and did not either get repaid or document the loans he made.  In short,’ the court concluded, Hassid ‘did not respect the separate legal existence of the very entity he created to shield himself from liability.’” Id. at *3-4 (brackets and ellipsis in original) (quoting trial court).  Second, the court found an “‘unjust result’” would occur if Mr. Hassid and Sunset were not jointly and severally liable, because “‘the plaintiff[s] would be deprived of an effective remedy for the extremely cavalier choices made personally by [Hassid] which resulted in such catastrophic damages to the structure that its occupants must vacate it for at least 270 days while it is being reconstructed.’” Id. at *4 (brackets in original) (quoting trial court).

While the decision in this case is unpublished and non-citable in subsequent actions, the lessons learned from the court’s analysis are significant: (1) establish and follow standard corporate formalities with any LLC used on a construction project development, and (2) ensure that the building materials selected are accepted as standard and reasonable in the industry for the application.  Finally, as questions arise regarding any LLC’s construction operations, consult an attorney to determine the best legal obligations and course of action for the corporate entity.

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Andrew Gibson helps his clients build successful projects and negotiate and resolve disputes. As a partner in Stoel Rives’ Real Estate, Construction and Design practice, Andrew is experienced in drafting and negotiating all forms of project documents, from the design phase through construction…

Andrew Gibson helps his clients build successful projects and negotiate and resolve disputes. As a partner in Stoel Rives’ Real Estate, Construction and Design practice, Andrew is experienced in drafting and negotiating all forms of project documents, from the design phase through construction, and regularly  assists clients with navigating the typical tricks and traps of contracting and insurance coverage issues. He is also a veteran of a variety of legal proceedings and has successfully pursued construction defect claims, insurance and bond claims, bid protests, stop payment notices, mechanic’s liens, real estate disputes, and collection actions through mediation, arbitration, and litigation.