Jun 62014

Alter Ego Liability – A Trap for the Unwary

If you formed a corporation or limited liability company, you probably did so to shield yourself and others from liability. Generally, shareholders, directors and officers are not personally liable for the debts of a corporation or LLC. However, under certain circumstances, California courts can “pierce the corporate veil” and allow creditors to go after individual corporate or LLC officials, holding them personally responsible for the debts and liabilities of the corporation or LLC.

A general understanding of the Alter Ego Doctrine and how the courts apply it is extremely important for anyone doing business through a corporation or LLC. Knowing what to do and not do in terms of corporate governance and finance can help you avoid many pitfalls and avoid financial catastrophe.

Two Elements
While there is no litmus test for applying the Alter Ego Doctrine, California courts have consistently stated that there are two general requirements necessary to pierce the corporate veil:

  1. There must be such a unity of interest and ownership between the corporation and its equitable owner that the separate personalities of the corporation and the shareholder (or other corporate entity) do not in reality exist; and
  2. There must be an inequitable result if the acts in question are treated as those of the corporation alone, or stated differently, the failure to disregard the corporate entity would sanction a fraud or promote an injustice.

Sufficient Unity of Interest
The first requirement – whether there is such a unity of interest that the separate personality of the corporation no longer exists – is often very fact intensive. The courts have stated that the following factors are relevant, though not necessarily conclusive, in determining whether the requisite unity of interest exists:

  1. Commingling of funds and assets.
  2. Failure to segregate funds.
  3. Diversion of funds or assets.
  4. Treatment by shareholder of corporate assets as own.
  5. Failure to maintain minutes.
  6. Identical equitable ownership in two entities.
  7. Officers and directors of one entity same as controlled corporation.
  8. Use of the same office or business location.
  9. Employment of same employees.
  10. Total absence of corporate assets.
  11. Under-capitalization.
  12. Use of corporation as mere shell.
  13. Instrumentality or conduit for single venture of another corporation.
  14. Concealment or misrepresentation of the responsible ownership, management and financial interests.
  15. Concealment or misrepresentation of personal business activities.
  16. Disregard of legal formalities.
  17. Failure to maintain arms-length relationships among related equities.
  18. The use of the corporate identity to procure labor, services or merchandise for another entity.
  19. The diversion of assets from a corporation by or to a stockholder or other person or entity to the detriment of creditors.
  20. The manipulation of corporate assets and liabilities in entities so as to concentrate the assets in one and the liabilities in another.
  21. The contracting with another with the intent to avoid performance by use of the corporation entity as a shield against personal liability.
  22. The use of the corporation as subterfuge for illegal transactions.
  23. The formation and use of a corporation to transfer to it the existing liability.

In considering the factors on this list, not every factor needs to be shown, and there is no one factor that is conclusive. The analysis often comes down to whether the corporation at issue is treated as a separate entity generally and at all times, and not simply for the purpose of shielding its shareholders or corporate affiliates from liability.

Inequitable Result

Like the first requirement, the second element – that there would be an inequitable result if the acts in question were treated as those of the corporation alone – is often highly fact intensive. Courts frequently state that the corporate form will not be recognized if to do so would sanction a fraud or promote injustice. The alter ego doctrine does not depend upon the presence of actual fraud, but is designed to prevent what would be fraud or an injustice. Accordingly, bad faith, in one form or another, is usually an underlying consideration. A finding of wrongdoing, violation of statute or evidence of injustice, is almost always required to pierce the corporate veil.

The information provided herein is not intended as legal advice and should not be acted upon. If you have additional questions about this subject matter or would like to consult with an attorney about this or related subject matters, please call or email Josef Cowan at the Cowan Law Group (949) 333-0919, jcowan@cowanlawgroup.com.

Filed by Joe Cowan, June 6, 2014