Piercing the Corporate Veil

Generally, California corporate law encourages business ventures and entrepreneurial activity by limiting liability exposure to the assets of the corporation, should a corporation be sued.  However, this is not an absolute protection.  Courts can and will disregard the corporate entity, allowing for individual shareholders, directors or officers (i.e. the “alter-egos”) to be held liable in certain circumstances. This is known as “piercing the corporate veil.”

California courts can pierce the corporate veil when both of the following two requirements are met:

(1) Unity of Interests – The shareholders in question have treated the corporation as their “alter ego,” rather than as a separate entity; and

(2) Inequitable Result – Upholding the corporate entity and allowing for the shareholders to dodge personal liability for its debts would “sanction a fraud or promote an injustice.”

In California, courts apply a factor-by-factor test to determine whether “alter-ego” liability is apropriate.  These factors include, but are not limited to, the following:

• Absence or inaccuracy of corporate records;
• Concealment or misrepresentation of members;
• Failure to maintain arm's length relationships with related entities;
• Failure to observe corporate formalities in terms of behavior and documentation;
• Failure to pay dividends;
• Intermingling of assets of the corporation and of the shareholder;
• Manipulation of assets or liabilities to concentrate the assets or liabilities;
• Non-functioning corporate officers and/or directors;
• Significant undercapitalization of the business entity (capitalization requirements vary based on industry, location, and specific company circumstances);
• Siphoning of corporate funds by the dominant shareholder(s);
• Treatment by an individual of the assets of corporation as his/her own;
• The corporation being used as a "façade" for dominant shareholder(s) personal dealings; alter ego theory;

In practice, the alter-ego doctrine is usually applied where the shareholders have not respected their corporation’s separate identity.  This means that it is vitally important that you, as the owner(s) of a corporation, take the following steps:

1. Have a separate corporate bank account and never co-mingle personal and business funds.
2. Have annual meetings of shareholders and directors and maintain minutes for all meetings which document all major business decisions.
3. Maintain a corporate book with the bylaws, and a stock transfer ledger, and amend these documents as appropriate and necessary.
4. Issue shares of stock to all shareholders.
5. File the Statement of Information annually with the California Secretary of State.
6. Ensure that all contracts related to the business are entered into by the corporation, signed by an appropriate officer or director of the corporation, and are never signed by you as an individual.
7. Ensure that all invoices sent out by the company are in the company name.
8. Set up a business office.
9. Ensure adequate business capitalization, i.e. ensure the company has enough money and equipment necessary to start and continue operations.

Remember:  if a judge cannot distinguish between what belongs to the business and what belongs to you individually, and you cannot provide proof that all formalities have been followed, a judge can "pierce the corporate veil" and award your personal assets to any plaintiff who sues you. 
 

If you ever have questions about piercing the corporate veil, or if you need our assistance in ensuring that all corporate formalities are being followed, please do not hesitate to call Suzuki Wuori, LLP at (619) 462-0995.