Corporate Litigation: What Is Alter Ego?
Los Angeles corporate litigation lawyers will tell you that one of the most often used concepts in California business litigation is that of alter ego. Alter ego is an attempt by a litigant to get past the protections of a corporate entity. In lawsuits regarding small corporations the phrase “pierce the corporate veil” is used to describe an attempt to disregard the corporate protections to go after the founder of the corporation personally. In larger corporate litigation alter ego is also used go after a corporate subsidiary’s larger corporate owner.In general the idea of alter ego is to disregard a corporate entity in order to get to the real money.
In the eyes of the law a corporation is a separate entity. With larger, more established corporations, a judgment against the corporation may be easily collectible. However, in smaller corporations, including family-owned businesses, the profits of the corporation may be distributed to the shareholders, leaving the corporation without any real assets or money. An attorney who gets a judgment against a small family-owned may have no way to collect, even though the founder is personally very wealthy.
The general rule is that before a corporation’s acts and obligations can be legally recognized as those of a particular person, and vice versa, the trial lawyer must make it appear that the corporation is not only influenced and governed by that person, but that there is such a unity of interest and ownership that the individuality, or separateness, of such person and the corporation has ceased. The California Court of Appeals, in affirming alter ego cases, often explains that in the case at hand the adherence to the fiction of the separate existence of the corporation would sanction a fraud or promote injustice.
It is not enough for a trial attorney to merely show that a creditor will remain unsatisfied if the corporate veil is not pierced. There must be some conduct amounting to bad faith that makes it inequitable for the equitable owner of a corporation to hide behind its corporate veil.
The court will look at a number of factors in determining alter ego. The domination of ownership and control of the corporation by certain individuals is one factor but not in isolation. The mere existence of a closely held corporation, for example, is not enough to establish domination. Instead, the individual shareholders must generally have treated corporate assets as their own and disregarded the separate nature of the corporate entity.
The trial court will look at the commingling of funds and other assets of the two entities (or the entity and the individual). Does the corporation pay the personal debts of the individual shareholder? Does the individual shareholder use the corporate bank account as his own personal bank account? Does one entity (or the individual) hold itself out as liable for the debts of the other? Is there identical ownership in the two entities? If two entities, do they use the same offices and employees? Is the one subsidiary or related corporation a mere shell or conduit for the affairs of the other corporation?
Other factors that have been described in the case law include inadequate capitalization, disregard of corporate formalities, lack of segregation of corporate records, and identical directors and officers. No one characteristic governs, but the court must look at all the circumstances to determine whether the doctrine should be applied.
Overall, alter ego is meant as a drastic remedy and, theoretically, sparingly used. Unless some wrong directly results from recognizing the separateness of the corporate entity, the alter ego doctrine cannot be used. Because society recognizes the benefits of allowing persons and organizations to limit their business risks through incorporation, sound public policy dictates that imposition of alter ego liability be approached with caution. Corporate veils exist for a reason and should be pierced only reluctantly and cautiously. The law permits the incorporation of businesses for the very purpose of isolating liabilities among separate entities.
If your business is engaged in commercial litigation and facing allegations of alter ego, your attorney should do an analysis of these factors to determine whether you as an individual are at risk of personal liability for the corporation’s debts. If you are a plaintiff pursuing a shell corporation, your lawyer should look to see if there are potential alter ego individuals or corporations whom you can pursue.