Piercing the Corporate Veil
Alter Ego Doctrine
Joint Enterprise Liability
The concepts of Piercing the Corporate Veil and Alter Ego are important to the following:
- Plaintiffs and their attorneys
- Defendants and their attorneys
- Corporation shareholders
- Corporation directors
- Members of Limited Liability Companies
- Operating Managers of LLCs
- People intending to form a corporation or limited liability company for asset protection purposes
Most people form corporations to insulate themselves from liability. The insulation exists because corporations are generally considered by law to be separate and distinct from their shareholders. For example, if a judgment is entered against a corporation, its shareholders will not be liable to pay the judgment except to the extent that shareholders have invested money by purchasing stock. This protection is often referred to as the corporate veil. While most people who incorporate believe they have no personal liability for the debts of the corporation, this is not always true.
Courts can disregard or pierce the corporate veil in situations where the shareholders disregard the legal separateness and the corporation acts as the alter ego of the shareholders in their dealings with third parties.
Alter ego is a legal theory that can apply to many defendants, and consequently, it can significantly expand the ability of a plaintiff's attorney to reach individuals and entities otherwise protected by the corporate veil. For example, corporations with subsidiaries or affiliates may be named as defendants in law suits on the ground that they are not actually separate. Thus, a corporate shareholder's exposure to liability may be greatly expanded.
In order for a court to determine that a corporation is the alter ego of the shareholders, two elements must be established.
First, there must be such a unity of interest and ownership that the separate personalities of the corporation and the shareholder (or the other entity) no longer exist, and secondly, that there will be an inequitable result if the acts are treated as those of the corporation alone.
Following are some of the factors that courts evaluate when determining whether to pierce the corporate veil:
- Whether the funds of the shareholders and corporation have been kept separate or commingled
- Whether the corporation follows corporate formalities (maintaining minutes, observing bylaws, electing directors)
- Inadequate capitalization making the corporation a mere shell, conduit or instrumentality of the shareholders
- Non-functioning directors
- Whether shareholders are withdrawing funds or assets from the corporation for personal use without justification or documentation
- Adequacy of insurance to protect third parties
- Did the corporation comply with the law
- Was the corporation properly licensed for its intended activity
- Did the corporation issue stock to the shareholders
- Whether the corporation conducts all of its business in the corporate name
- Did the corporation engage in transactions with shareholders that were not at arms length
- Have the shareholders placed any of the corporate assets on their personal financial statements given to third parties
- Was the corporation used as an instrumentality or agent of the shareholders
- Would there be an inequitable result if the corporate veil is used as a defense
Since corporate minutes are a first line of defense, they should include resolutions regarding the following:
- Approval of large contracts
- Compensation of officers
- Acquisition or sale of significant assets
- Designation of banking institutions
- Approval of guarantees
- Declarations of dividends
- Approval of loans
- Adoption of employee benefit plans
- Authorization to sign documents and checks
While limited liability companies are not required to maintain the same formalities as corporations and the law on the subject is less clear, the veil of protection afforded by the creation of LLCs can still be pierced by a court if the two elements described above are satisfied.
In summation, alter ego is a well accepted principle in California. In developing the alter ego doctrine, California courts have balanced two competing considerations. On the one hand, they recognize that the law permits the incorporation of businesses for the purpose of isolating liabilities among separate entities. Since society recognizes the benefits of allowing persons and organizations to limit their business risks through incorporation, sound public policy dictates that disregard of those separate corporate entities be approached with caution. On the other hand, they have also emphasized that it would be unjust to permit those who control companies to assert their separateness in order to commit frauds and other misdeeds with impunity.
Closely related to the alter ego doctrine is the doctrine of joint enterprise liability or enterprise liability. While piercing the corporate veil provides a mechanism for holding a shareholder (person or entity) liable for the debts of the corporation, joint enterprise liability provides a mechanism for holding a non-shareholder liable for the debts of a corporation.
A joint enterprise is defined as an enterprise created by two or more persons or entities, by express or implied agreement, that have a common purpose and equal rights of control.
In order for a court to determine that joint enterprise liability exists, two elements must be established:
First, there must be such a unity of interest between the two (or more) entities that their separate existence has de facto ceased, and secondly, that treating the two entities as separate would promote an injustice.
If you need a referral to an attorney to protect your interest, please contact Michael Chulak.