The law governing California limited liability companies evolves in real time | Lessons from the courtroom battlefront

An LLC And Its Owner Are Not the Same Legal “Person”

A limited liability company (LLC) is a popular form of business entity.  One of the main reasons for forming any business entity is to limit liability.  In general, without a showing of “alter ego” liability, a business owner will not be personally liable for the obligations of the business.

This fundamental concept is well entrenched in California and elsewhere.  But every now and then, it gets tested in court cases involving different factual twists.

In an opinion recently published by California’s Sixth District Court of Appeal — Orozco v. WPV San Jose, LLC — the court addressed whether a closely related commercial lease and lease guaranty could be treated separately, when one was signed by an LLC and the other was signed by the LLC’s owner.

Facts: LLC signs commercial lease; LLC’s owner signs guaranty

Paul Orozco operated Pauly’s Famous Franks N Fries (Pauly’s) a restaurant serving gourmet hot dogs, sausages, and specialty french fries at The Plant shopping center in San Jose.  Orozco was also the 100% owner of Solid Restaurant Ventures, an LLC he formed to operate Pauly’s.

Before signing a ten-year lease at The Plant on behalf of the LLC, Orozco asked the landlord’s leasing manager whether any restaurants with competing concepts were being considered for the remaining unfilled buildings.  The leasing manager assured Orozco that no such restaurants were being considered, even as she was negotiating a lease with Al’s Beef, a national franchise selling hot beef sandwiches, hot dogs, and french fries.

Orozco signed the lease on behalf of his LLC, and also signed a lease guaranty as an individual guarantor.

Pauly’s debut was successful, but after a few months Al’s Beef opened two stores down, and Pauly’s sales crumbled.  Within six months, Pauly’s closed.

The LLC and Orozco sued the landlord for fraud and rescission.

Trial court: lease and guaranty are intertwined; no separate remedy for LLC owner

Following a trial, the jury rendered verdicts that the landlord had committed fraud.

The LLC elected a damages remedy instead of rescission, and the LLC was awarded damages caused by the fraud.

Orozco, however, continued pursuing rescission of the guaranty.  But the trial court ruled that Orozco could not obtain rescission of the guaranty because the lease and guaranty were intertwined, the LLC had elected damages over rescission, and Orozco had suffered no individual harm.

Court of Appeal’s Opinion: LLC and owner are entitled to separate remedies

The Court of Appeal reversed, holding that the LLC and Orozco were “two distinct juridical persons.”

Orozco was individually damaged, the court held, by entering into the guaranty “that he would not have freely entered into if he had known about Al’s Beef.”  The court held that Orozco did not need to prove pecuniary loss to be entitled to rescission, concluding that “anyone who is fraudulently induced to enter into a contract is ‘injured'” sufficiently to allow for rescission.

The court also disagreed with the trial court’s holding that the lease and guaranty were too intertwined to allow different remedies.  The court stated:

It is settled that one who has suffered injury both as an owner of a corporate entity and in an individual capacity is entitled to pursue remedies in both capacities.  In other words, the trial court asked the wrong question ….  The relevant question was not whether the lease and guaranty were separate but instead whether Orozco and [the LLC] were legally separate entities.

Because the LLC was legally distinct from Orozco, they were each entitled to separate remedies — damages for the LLC, and rescission for Orozco.

Lesson

An LLC and its owner are not the same legal “person.”  When an LLC and its owner sign separate — albeit related — legal documents, they each have their own rights and remedies.

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