Piercing the Corporate Veil – Alter Ego Liability Considerations

By | September 28, 2010

The following is a relatively completely list of factors that may be considered by a court in piercing the corporate veil (i.e. finding alter ego liability) where an individual may be held liable for acts committed through their corporate or limited liability company entity.

(1) Commingling of funds and other assets of the corporation with those of the individual shareholders.

(2) Diversion of the corporation’s funds or assets to non-corporate uses (especially the personal use of the shareholders).

(3) Failure to maintain the corporate formalities necessary for the issuance or subscription to the corporation’s stock, such as formal approval of the stock issue by an independent board of directors.

(4) An individual shareholder representing to persons outside the corporation that he or she is personally liable for the debts or other obligations of the corporation.

(5) Failure to maintain corporate minutes or adequate corporate records. (Note: California LLCs are not required by law to maintain minutes of annual meetings, but may if they elect to do so.)

(6) Identical equitable ownership in two entities (i.e. Corporation A is owned by the same shareholders and in the same proportions as Corporation B).

(7) Identity of the directors and officers of two entities who are responsible for supervision and management (i.e. a partnership and corporation owned and managed by the same parties).

(8) Failure to adequately capitalize a corporation for the reasonable risks of the corporate undertaking.

(9) Absence of separately held corporate assets.

(10) Use of a corporation as a mere shell or conduit to operate a single venture or some particular business of an individual or another corporation.

(11) Sole ownership of all the stock by one individual or members of a single family.

(12) Use of the same office or business location by the corporation and its individual shareholder(s).

(13) Employment of the same employees or attorney by the corporation and its individual shareholders(s).

(14) Concealment or misrepresentation of the identity of the ownership, management, or financial interests of the corporation, and concealment of personal business activities of the shareholders (e.g. sole shareholders do not reveal the association with the corporation which makes loans to them without adequate security).

(15) Disregard of legal formalities and failure to maintain proper arm’s length relationships among related entities.

(16) Use of a corporate entity as a conduit to procure labor, services, or merchandise for another person or entity.

(17) Diversion of corporate assets from the corporation by or to a stockholder or other person or entity to the detriment of creditors, or the manipulation of assets and liabilities between entities to concentrate the assets in one and the liabilities in another.

(18) Contracting by the corporation with another person with the intent to avoid the risk of nonperformance by use of the corporate entity, or the use or the corporation as a subterfuge for illegal transactions.

(19) The formation and use of the corporation to assume the existing liabilities of another person or entity.

The precise requirements to justify piercing of the corporate veil have rarely been clearly articulated in case precedent. A lawsuit in which a party seeks to disregard the corporate entity (i.e. pierce the corporate shield) sounds in equity and the trial court is generally given a great deal of latitude in determining relief. The court must balance the public policies behind insulating shareholders from liability against policies which justify piercing. As a basic rule, several factors must exist.

It is advisable to avoid as many as possible of these factors. While some are the result of smaller, family-owned corporations doing normal day-to-day business (e.g. sole shareholders, use of same offices, employment of same professionals), other factors are not as easily explained away and should be more heavily weighted. The factors which can easily be avoided are (a) commingling of funds (i.e. separate bank accounts); (b) diversion of funds (i.e. never use corporate funds for questionably personal uses); (c) failure to keep adequate minutes or records (i.e. maintain documentation and hold regular meetings); (d) same shareholders (i.e. employees may obtain stock interest in the future); (e) same directors (i.e. maintain independent boards with uninterested directors); (f) maintaining separate corporate assets; and (g) employment of same employees. The court determined whether the corporate shield will be maintained on a case-by-case basis; therefore, there is no easy formula which will guarantee no personal liabilities, but these factors are key issues to consider.

Disclaimers: This information is provided as general information regarding an emerging legal question for discussion and does not constitute legal advice concerning your specific situation or create any attorney-client relationship with the law offices of Cathy Cowin. Further, the law offices of Cathy Cowin is licensed in the state of California and does not purport to offer advice outside of the scope of its license. The law offices of Cathy Cowin does not undertake any responsibility to update this information or guarantee that it remains current law. Consult with legal counsel regarding your particular facts and circumstances.

Cathy Cowin practices law in Fresno, California and is a member of the LawGuru Attorney Network.

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