The Alter Ego Doctrine – And Why You Should Care About It
There is one risk common to everyone in business – whether you are a small company or a large company; whether you sell a product or provide a service; whether you have been in business for five minutes or 100 years. That risk is exposure of your personal assets to satisfy the liabilities of your company or business.
Most everyone, at the start of their business, spends time, money and mental anguish ensuring that their business structure is one that protects them from personal liability. This is done so in case your company is sued, the plaintiff cannot reach your personal bank accounts, investment accounts or equity in your home or other real property owned by you, individually. After all, that is why legal entities such as corporations, limited liability companies (“LLC”) and limited liability partnerships (“LLP”) are formed. And that is why you – as a company owner – most likely, spent money on legal fees to have such a structure set up for your business; or why you – as an attorney – advised your client to create such a structure. But if you are not observing the “corporate formalities,” (some of which are likewise applicable to LLCs and LLPs) the time and money you spent on that legal structure is wasted.
Like most business people, your main focus, from a business standpoint on a day to day basis, is your company – not its legal structure. Your energies and attention are focused on ensuring that your business runs smoothly, is profitable and that your clients/customers/ patients are happy. That is why the alter ego doctrine is so effective and why it is widely utilized by plaintiffs. Oddly enough, the very needs and demands of a business are exactly what put you in the cross-hairs of the alter ego doctrine. Things like having to infuse money into your business; being a sole shareholder; not having time for corporate meetings; and even strategies to limit risk like forming more than one entity are the types of things that can put you at risk for personal liability.
Even after a lawsuit is over and you were not named as a defendant individually, you still may be at risk if your company is unable to satisfy the judgment against it. In such instances, after trial, the plaintiff can ask the court to amend the judgment and add you, individually, as an additional judgment debtor by means of a summary proceeding, without the benefit of a court trial.
The alter ego doctrine has been around since the beginning of corporation law. It is also referred to as “piercing the corporate veil.” Typically, a corporation, LLC or LLP creates a layer of separation between you, as an individual, and your business. You and your corporation, LLC or LLP are not the same “person.” However, under the alter ego doctrine, that protection is reduced or eliminated.
In order to safeguard that layer of protection, i.e., the corporate veil, a business owner has to observe corporate formalities – issue stock, have corporate meetings, avoid commingling assets, adequately capitalize their entities, etc. As non-lawyers, business owners may not have these issues at the forefront of their day to day operations, and may act in accordance with what the business demands or needs – as needed to succeed.
Recently, the alter ego doctrine has gained even more strength. Before 2013, the elements necessary to prove alter ego and reach the assets of an individual included a showing of “bad faith” which led to an “inequitable result,” i.e., the individual company owner undertook some deliberate, malicious act or conduct to prevent the corporate defendant from paying on a judgment or liability. Thus, if you acted in “good faith” you were, basically, “ok.” That changed in 2013 with the case of Relentless Air Racing, LLC v. Airborne Turbine LTD. Partnership (2013) 222 Cal.App.4th 811. The Relentless Air Court held that the mere inability to pay a judgment, constitutes an “inequitable result” and, therefore, the corporate veil may be pierced to reach the individual assets of a company’s owner(s).
And it is not just the individual owner’s assets that may be at stake. Another aspect of alter ego is the “single enterprise” rule. Under that rule, if your business requires the creating of more than one corporation, LLC or LLP and corporate formalities are not followed, courts have held that all of the entities comprise a “single enterprise,” and the assets of any of the companies within the enterprise, as well as the assets of their owner(s), may be reached. Such structures are commonly used, and have been commonly used for many years, by real estate companies/developers who create a new entity for each of their projects. Not properly capitalizing each and every one of those “separate” entities may lead to corporate veil piercing under the “single enterprise” rule, putting at risk the assets of the entire enterprise. [Greenspan v. LADT, LLC (2010) 191 Cal.App.4th 486, 508; Las Palmas Associates v. Las Palmas Center Associates (1991) 235 Cal.App.3d 1220.]
The alter ego concept is not new, but due to its expansion by California courts over the last few years more business owners are getting caught in the alter ego web. If you have questions or concerns about such liability, I encourage you to seek an alter ego audit for your business.