It often happen that creditors and plaintiffs against corporations and LLCs in California find that the corporation has no assets from which to collect. They then want to collect from the individuals behind the entity. A shareholder (or LLC member) may also be liable for the corporation or LLC’s obligations under the common law “alter ego” doctrine (called ‘piercing the corporate veil’). Courts regard the alter ego doctrine as a drastic remedy and do not easily disregard the corporate form, so Creditors and plaintiffs should consult with an experienced Sacramento and El Dorado business attorney.
The corporate entity may be disregarded and the shareholders held personally liable for corporate debts because of the manner in which they have dealt with the corporation. There are two requirements:
Unity of interests: First, the shareholders sought to be held liable have treated the corporation as their “alter ego,” rather than as a separate entity; and Resulting injustice: Second, it would “sanction a fraud or promote an injustice” to uphold the corporate entity and allow the shareholders to escape personal liability for its debts.
The courts that have looked at unity of interest have discussed a variety of factors which were important under the facts of their particular case.
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. the treatment by an individual of the assets of the corporation as his own;
3. the failure to obtain authority to issue stock or to subscribe to or issue the same;
4. the holding out by an individual that he is personally liable for the debts of the corporation;
5. the failure to maintain minutes or adequate corporate records, and the confusion of the records of the separate entities;
6. the identical equitable ownership in the two entities; the identification of the equitable owners thereof with the domination and control of the two entities;
7. identification of the directors and officers of the two entities in the responsible supervision and management; sole ownership of all of the stock in a corporation by one individual or the members of a family;
8. the use of the same office or business location; the employment of the same employees and/or attorney;
9. the failure to adequately capitalize a corporation; the total absence of corporate assets, and undercapitalization;
10. the use of a corporation as a mere shell, instrumentality or conduit for a single venture or the business of an individual or another corporation;
11. the concealment and misrepresentation of the identity of the responsible ownership, management and financial interest, or concealment of personal business activities;
12. the disregard of legal formalities and the failure to maintain arm’s length relationships among related entities;
13. the use of the corporate entity to procure labor, services or merchandise for another person or entity;
14. the diversion of assets from a corporation by or to a stockholder or other person or entity, to the detriment of creditors, or the manipulation of assets and liabilities between entities so as to concentrate the assets in one and the liabilities in another;
15. the contracting with another with intent to avoid performance by use of a corporate entity as a shield against personal liability, or the use of a corporation as a subterfuge of illegal transactions;
16. the formation and use of a corporation to transfer to it the existing liability of another person or entity.
Courts that have disregarded the entity have relied on several factors, but none of them are conclusive; they are weighed in balance with others. But, a unity of interests is not the only step. On finding the unity of interest, the courts then look at whether respecting the entity would work some fraud or injustice on the creditor.
Overall, this can be a useful tool in getting paid, but it is not easy. A large amount of evidence is required to show the unity of interest, and often requires extensive discovery in litigation, but the payoff may be worth it.