California Business Divorce Blog: Destruction of LLC Records Will Likely Subject LLC Owners to Personal Liability in a Business Divorce Dispute
In a recently published opinion, Hacker v. Fabe, 92 Cal. App. 5th1267 (2023), the California Court of Appeal found that an LLC owner’s destruction of the company’s records was a substantial factor that subjected him to personal liability for the debts owed to a departing member by the LLC.
In 2005, Jacqueline Fabe, an attorney, filed a claim for unpaid wages with the Labor Commissioner against her employer, 1538 Cahuenga Partners, LLC. In response, the LLC’s managing member, Ron Hacker, filed a lawsuit against Fabe claiming she committed malpractice. Fabe, in return, filed a retaliation claim with the Labor Commissioner. She prevailed on her retaliation claim, and the Commissioner thereafter sued the LLC for Fabe’s defense costs against the illegal retaliation claim. Following a trial, Fabe and the Commissioner prevailed on all of their claims against the LLC and judgment in excess of $100,000 was entered against the LLC.
Ordinarily, Fabe would only be able to collect that judgment against the LLC and not its owners, including managing member Hacker. Here, the LLC did not have any money, so Fabe typically would not have been able to collect on her judgment against the LLC.
However, California recognizes that in certain cases there may be such a unity of interest between the LLC and one or more of its owner/managers, that a judgment creditor may collect on a judgment against the owner/managers of the LLC as well. This commonly is referred to as alter ego liability. However, until this case, a destruction of the LLC’s records was not one of the factors to be considered in deciding whether an owner should be personally liable for the debts/judgments of an LLC.
Under Troyk v. Farmers Grp., Inc., 171 Cal. App. 4th1305 (2009), and other applicable California cases, the usual factors for determining alter ego liability include commingling of funds, treatment by an individual of the assets of a corporation as his or her own, the failure to maintain corporate minutes and records, the use of the LLC as shell for single venture or the business of individual, and the diversion of corporate assets for personal use among others.
Here, however, managing member Hacker conceded in a judgment debtor examination that documents relating to the LLC’s earnings and finances during the relevant time period had been in his possession and control at one point and that he had destroyed them. In finding Hacker personally liable to Fabe for the $100,000 judgment she had against the LLC, the court found many of the alter ego factors applied, including Hacker’s complete control over the LLC and his transfer of control over the LLC to a third party immediately after the judgment was entered. However, the Court also repeatedly referred to Hacker’s admitted destruction of the LLC’s records as the basis for its decision to hold him personally liable to attorney Fabe.
Moving forward, managing members of an LLC can and should anticipate that their handling of LLC records will be a major focus of discovery in future disputes where a plaintiff seeks to hold them personally liable for the debts of the LLC and, once a lawsuit is filed against an LLC, they should take immediate steps to ensure that potentially relevant LLC records are preserved and not destroyed, including issuing company wide preservation letters and turning off auto delete functions in databases and email platforms in order to avoid an alter ego finding against them.
