Drosman & Percival LLP

When a corporation is sued, as a general rule its shareholders are not liable for a judgment against the corporation. This is the "corporate veil" of protection. Once a shareholder invests his or her money into the corporation, the shareholder is generally not liable for any other money the corporation may need, such as money to pay an adverse legal judgment. However, in some circumstances, it is possible to pierce the corporate veil and hold a shareholder personally liable for the corporation’s debts.

Courts have held that piercing the corporate veil is "an extreme remedy, sparingly used." Furthermore, the plaintiff in a lawsuit has the burden of proving that the corporate veil should be pierced.

The legal standard for piercing the corporate veil is a vague one that can fit many different circumstances. Generally, to pierce a corporate veil the plaintiff must prove two things: (1) there is a "unity of interest and ownership" between the corporation and its owner, and (2) it would be unfair if the acts in question are treated as those of the corporation alone. Given this vague standard, California courts have developed a number of factors they will consider when determining whether this two part test is met, including:

1.  Commingling of funds and other assets, failure to segregate funds of the separate entities, and the unauthorized diversion of corporate funds or assets to other than corporate uses;
 
2.  Treatment by an individual of the assets of the corporation as his own (e.g., paying personal debts with corporate funds);

3.  Failure to obtain authority to issue stock;

4.  An individual stating that he or she will be liable for the debts of the corporation;

5.  Failure to follow corporate technicalities, such as maintaining records, holding board or shareholder meetings, or having officers;

6.  When two corporations are claimed to be alter egos, both corporations having identical owners, directors and officers;

7.  Same office or business location;

8.  Employment of the same employees and/or attorney;

9.  Failure to adequately capitalize a corporation, the total absence of corporate assets, and undercapitalization;

10.  Use of a corporation as a shell or as an instrument for a single venture (e.g., using a corporation to enter contracts that personally benefit the owner or one of the owner’s other companies);

11.  Concealment or misrepresentation of the identity of the responsible ownership, management and financial interest;

12.  Use of the corporate entity to procure labor, services or merchandise for another person or entity;

13.  Diversion of assets from a corporation by or to a stockholder or other person or entity, to the detriment of creditors;

14.  Manipulation of assets and liabilities between entities so as to concentrate the assets in one and the liabilities in another;

15.  Contracting with another with intent to avoid performance by use of a corporate entity as a shield against personal liability;

16.  Use of a corporation as a subterfuge of illegal transactions;

17.  Formation and use of a corporation to transfer to it the existing liability of another person or entity.

These are some of the factors courts will consider. In many respects, the question may come down to an issue of fairness: Will a creditor of a corporation be treated unfairly if the corporation’s "veil" is not pierced?

With these loose and varied factors, it is not possible to address everything business owners should consider to avoid a finding of alter ego. But key factors business owners should observe include adequately capitalizing their corporation, adhering to corporate procedures, not intermingling funds and not using corporate funds for personal debts.

This article constitutes general information only and should not be relied upon as legal advice.