David H. Schwartz
Understanding Alter Ego Liability
A corporate identity protects its shareholders and those operating the corporation from being personally liable for any debt obligations or other financial liabilities, provided that the business is operated as a corporation and follows all the legal requirements concerning proper operational behavior — observing board and shareholder meetings as well as fulfilling all recordkeeping and filing obligations.
The phrase “piercing the corporate veil” refers to a legal challenge to prove that a business operating as a corporation is really just “a collection or association of individuals” rather than a separate legal entity. This is called the doctrine of “alter ego.” The corporation is being abused and is functioning as the alter ego of a “collection or association of individuals,” or perhaps even of just one individual.
If the corporate veil is pierced through court proceedings, then the shareholders can be held responsible for liabilities. California courts are generally reluctant to take such a drastic step, but there are legal precedents up to and including the state Supreme Court regarding the alter ego doctrine and the piercing of the corporate veil.
If you’re involved in an alter ego legal proceeding, whether as plaintiff or defendant, rely on the experience, knowledge, and resources of the Law Offices of David H. Schwartz, INC. Attorney David H. Schwartz serves clients in and around San Francisco, including San Jose, Santa Clara, Oakland, San Mateo, and Alameda County.
California Law & the Doctrine of Alter Ego
“Alter ego” literally means a person’s secondary or alternative self, kind of like Dr. Jekyll and Mr. Hyde, but perhaps not always that stark. In a legal situation involving a corporation, an alter ego refers to a corporation that has become the handmaiden of shareholders or officials running the business rather than being run as an independent entity.
In 1985, the California Supreme Court took up the doctrine of alter ego in corporate governance and concluded in Mesler v. Bragg Management Co. that:
"As the separate personality of the corporation is a statutory privilege, it must be used for legitimate business purposes and must not be perverted. When it is abused, it will be disregarded and the corporation looked at as a collection or association of individuals, so that the corporation will be liable for acts of the stockholders or the stockholders liable for acts done in the name of the corporation."
The question before the court then (and now) is how to determine when a corporation becomes “a collection or association of individuals.” In the same case, the court ruled:
“There is no litmus test to determine when the corporate veil will be pierced; rather the result will depend on the circumstances of each particular case. There are, nevertheless, two general requirements: (1) that there be such unity of interest and ownership that the separate personalities of the corporation and the individual no longer exist and (2) that, if the acts are treated as those of the corporation alone, an inequitable result will follow.’"
On the first point, California courts have identified telltale signs that the corporate veil may have been pierced through the alter ego actions of shareholders and/or officers by, among other actions:
- Commingling of funds and other assets
- Diverting corporate funds or assets to other than corporate purposes
- Treating corporate assets by an individual as if they were his own
- Failing to maintain minutes and adequate corporate records
- Treating the corporation as a mere shell for the business of an individual or other corporation
- Concealing the identity of responsible ownership, or concealing personal business activities
On the second point — “inequitable result will follow” — in 2000, in Sonora Diamond Corp. v. Superior Court, the court ruled: “The alter ego doctrine does not guard every unsatisfied creditor of a corporation but instead affords protection where some conduct amounting to bad faith makes it inequitable for the corporate owner to hide behind the corporate form.”
In short, the plaintiff who is trying to pierce the corporate veil must show that “conduct amounting to bad faith” resulted in inequitable results.
Turn to an Experienced Attorney
Piercing the corporate veil through the alter ego doctrine is challenging. Courts are reluctant to pierce the veil without adequate proof that the corporation is not pursuing business interests on its own, but has become the vehicle of certain shareholders or officers.
If you wish to pursue an alter ego case against a corporation, you will need to assemble solid evidence to present in court. On the other hand, if your corporation is being challenged by the doctrine of alter ego, you are going to need to show you have been following proper corporate protocol and legal standards. Either way, you’re going to need the legal counsel and guidance of an experienced attorney.
Contact the Law Offices of David H. Schwartz, INC.
If you’re in or around the greater San Francisco Bay Area, including Oakland, San Jose, Santa Clara, San Mateo, and Alameda County, contact the Law Offices of David H. Schwartz, INC. Attorney David H. Schwartz has 45 years of experience in pursuing claims against others and in defending those who are facing claims. Reach out for skilled legal representation today.