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Piercing the Corporate Veil
Alter Ego Doctrine
Joint Enterprise Liability
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The concepts of Piercing the Corporate Veil and Alter Ego are important to the
following:
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Plaintiffs and their attorneys |
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Defendants and their attorneys |
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Corporation shareholders |
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Corporation directors |
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Members of Limited Liability Companies |
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Operating Managers of LLCs |
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People intending to form a corporation or limited liability
company for asset protection purposes |
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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:
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Whether the funds of the shareholders and corporation have been
kept separate or commingled |
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Whether the corporation follows corporate formalities
(maintaining minutes, observing bylaws, electing directors) |
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Inadequate capitalization making the corporation a mere shell,
conduit or instrumentality of the shareholders |
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Non-functioning directors |
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Whether shareholders are withdrawing funds or assets from the
corporation for personal use without justification or documentation |
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Adequacy of insurance to protect third parties |
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Did the corporation comply with the law |
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Was the corporation properly licensed for its intended activity |
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Did the corporation issue stock to the shareholders |
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Whether the corporation conducts all of its business in the
corporate name |
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Did the corporation engage in transactions with shareholders
that were not at arms length |
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Have the shareholders placed any of the corporate assets on
their personal financial statements given to third parties |
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Was the corporation used as an instrumentality or agent of the
shareholders |
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Would there be an inequitable result if the corporate veil is
used as a defense |
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Since corporate minutes are a first line of defense, they should include
resolutions regarding the following:
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Approval of large contracts |
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Compensation of officers |
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Acquisition or sale of significant assets |
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Designation of banking institutions |
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Approval of guarantees |
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Declarations of dividends |
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Approval of loans |
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Adoption of employee benefit plans |
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Authorization to sign documents and checks |
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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.
The attorneys with Michael T.
Chulak & Associates understand alter ego, piercing the corporate veil and
joint enterprise liability. We represent plaintiffs and defendants in
litigation throughout California.
Call Michael T. Chulak & Associates for a no cost
initial consultation.
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