One reason business owners or managers form corporations or limited liability companies (LLCs) is to ensure they are not personally liable for business debts if the company cannot pay its creditors. There are times, however, when courts will hold the corporation or LLC’s owners, officers, shareholders, or members personally liable for the business’s debts. This is commonly referred to as “piercing the corporate veil” or establishing “alter-ego” liability.
Requirements for Piercing the Corporate Veil
Courts evaluate the circumstances of each case rather than using a specific test to determine when to pierce the corporate veil. They look to see whether the case meets two general requirements:
- Unity of Interests; i.e., there is such unity of interest and ownership that the separate personalities of the corporation and the individual no longer exist, and;
- Inequitable Result; i.e., if the acts are treated as those of the corporation alone, an inequitable result follows.
Factors Courts Consider in Piercing the Corporate Veil
California courts use a non-exclusive, multi-factor test when deciding whether to pierce the corporate veil. These factors include:
- using the corporate form to commit fraud, circumvent a statute, or accomplish another wrongful or inequitable purpose;
- adding or withdrawing capital from the corporation at will;
- comingling funds and other assets;
- failing to segregate funds of the individual and the corporation;
- the unauthorized diversion of corporate funds to other than corporate purposes;
- the individual’s treatment of corporate assets as his own;
- failing to seek authority to issue stock or issue stock under existing authorization
- the representation by an individual that he is personally liable for corporate debts;
- failing to maintain adequate corporate minutes or records;
- intermingling individual and corporate records;
- the ownership of all the stock by a single individual or family;
- the domination or control of the corporation by the stockholders;
- using a single address for the individual and the corporation;
- inadequate corporate capitalization;
- using the corporation as a conduit for an individual’s business;
- concealing the ownership of the corporation;
- disregarding corporate formalities and failing to maintain arm’s-length transactions with the corporation; and
- attempting to segregate liabilities to the corporation.
Examples of Courts Applying the Alter-Ego Doctrine
OLILANG v. Herrera
In this 2017 unpublished decision, the court pierced the corporate veil and held defendants liable for several companies’ debts to plaintiffs. Evidence in support of the unity of interests requirement included that Defendant Michael Herrera owned most of the properties managed by one company. “[E]very transaction” a second company entered into involved Herrera. Herrera used a third company to hold properties he owned before transferring them for nominal consideration to shell entities “for the sole purpose of protecting them from plaintiffs[.] Additionally, substantial evidence supporting fraud meant an inequitable result would arise if the court did not apply the alter ego doctrine.
KH CORPORATION (HK) LIMITED v. Kim
In another 2017 unpublished decision, the court found that Defendant Mr. Kim was not the alter ego of corporation Five Stones. Kim did not comingle funds, he and Five Stones maintained separate accounts, and Five Stones observed formalities such as taking meeting minutes. The plaintiff did not offer evidence of comingled funds or assets, inadequate capitalization, or other support for the court to conclude it would be inequitable to treat Kim separately from Five Stones.
Evidence, however, that Kim was the sole owner of Five Stones, he invested $400,000 to launch Five Stones without a promissory note from Five Stones, and inconsistencies in Kim’s testimony regarding issued stock was “relevant but insufficient” for the court to find Kim was the alter ego of Five Stones.
Your Next Move
Check to see if any of the factors discussed above apply to you or your corporation or business. As the list is not exhaustive, discuss your current business practices and any concerns with a local attorney to make sure you and your personal assets are protected.