Alter Ego Liability Explained With Examples
As a general rule, a corporation is a separate legal entity that is distinct from its shareholders. In fact, one major benefit to incorporating a business is that the owners, or shareholders, are not personally responsible for corporate debts and obligations. However, under certain circumstances, the “corporate veil” can be pierced, and a litigant can hold the shareholders of a corporation liable for corporate debts and obligations. The rules governing this process are called the “alter ego doctrine.” We have written on this topic before, but we wanted to drill down with actual examples of how Courts ruled on this issue.
The Alter Ego Doctrine
Before the acts and obligations of a corporation can be legally treated as those of a particular person, it must be established that the corporation is not only influenced by that person, but also that any individuality or separateness between person and corporation has ceased (or never existed), and that under the circumstances, recognizing the separate legal existence of the corporation would result in fraud or promote injustice.
There are several factors, which the courts have considered in deciding whether or not to apply the alter ego doctrine. These factors have included:
- Failing to keep corporate and individual funds and other assets separate;
- Using corporate funds or assets for individual (non-corporate) purposes;
- Transferring corporate funds or assets to avoid corporate debts;
- Failing to adequately capitalize the corporation so that it has sufficient assets available to meet corporate debts;
- Representations by an individual that he or she is personally responsible for the debts of the corporation; and
- Failing to follow corporate formalities such as the holding of board of directors and shareholder meetings, and maintaining adequate minutes or other corporate records.
Applicability of the Alter-Ego Doctrine
The alter ego doctrine can apply to a number of different legal entities. The alter ego doctrine has been applied to holder shareholders liable for the debts of a corporation, members liable for the debts of a limited liability company, and business entities liable for the debts of other business entities which they own. Further, under certain circumstances, a business entity can be held liable for the debts of “sister company,” that it does not own, where there is in fact only one enterprise, and that enterprise has been handled in a manner that it should respond as a whole for debts of certain components of it.
Examples of Where the Alter Ego Doctrine Has Applied
In Misike v. D’Arco, a shareholder was held liable for a corporate debt under the alter ego doctrine where: (1) the shareholder owned 100% of the corporation’s shares; (2) the shareholder made all binding decisions for the corporation; (3) the shareholder was the only officer and director that the corporation ever had; (4) no meeting minutes were ever kept for the corporation; (5) the corporation never conducted business outside of the shareholder’s home residence, and never had a phone number other than the shareholder’s personal phone number; (6) at the time the transaction at issue occurred, the corporation’s liabilities exceeded its assets; (7) the corporation had no money in its bank account; and (8) the shareholder regularly paid for the corporation’s debts with his own personal funds.
In Toho-Towa Co., Ltd v. Morgan Creek Productions, Inc. a U.S. corporation was held liable under the alter ego doctrine for the debts of two foreign corporations where: (1) all three corporations were wholly owned by a single individual; (2) the work of all three corporations was performed by the same employees; (3) the three companies were operated in such a way that no money ever flowed to the two foreign corporations; (4) the foreign corporations had no bank accounts; and (5) the same general counsel handled the legal affairs of all three corporations.
In Automotriz del Golfo de California S. A. de C. v. Resnick, three shareholders were held liable for the debts of a corporation where: (1) the corporation failed to issue any stock, and never applied for a permit to issue stock; (2) the corporation was grossly undercapitalized; and (3) there was no bank account set up for the corporation.
Examples of Where the Alter Ego Doctrine Has Not Applied
In Hasso v. Hapke, a limited liability company was found to not be the alter-ego of its sister company where: (1) the limited liability company did not dominate or control the sister company; (2) there was not a common ownership between the companies; (3) the limited liability company was not involved in the sister companies business affairs; (4) there was no commingling of assets between the companies; (5) the companies maintained separate bank accounts, accounting books, and filed separate tax returns; (6) the companies each held meetings of their boards of directors to vote on important company actions, and minutes of these meetings were recorded; (7) the companies were not undercapitalized; and (8) neither company shared the assets or liabilities of the other.
In Sonora Diamond Corp. v. Superior Court, the alter ego doctrine did not apply to hold a corporation liable for the obligations of its wholly owned subsidiary where there was no evidence of any wrongdoing on the part of the parent corporation, and no finding that injustice would result by recognizing the subsidiary company’s corporate identity.
In Harris v. Curtis, three shareholders were not held liable for corporate debts under the alter ego doctrine where: (1) there was no commingling of corporate and private funds; (2) no corporate funds were used for non-corporate purposes; (3) no shareholder treated the assets of the corporation as their own; (4) no shareholder held themselves out as being personally liable for corporate debts; (5) corporate records and meeting minutes were adequately kept; (6) there was no sole ownership of the corporation by one individual or members of a family; and (7) there was no disregarding of corporation formalities or failure to maintain an arms-length relationship between the corporation and the shareholders.
See our other Alter Ego articles:
Can I Hold Corporation’s Owners Personally Responsible For Corporate Debt Through Alter Ego Or “Piercing The Corporate Veil”?
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