Alter-Ego and Why That Is an Ego You Need to Understand
It’s a common assumption that a corporation and its shareholders are generally treated as separate legal entities. Acts through a corporation are performed by its officers, and the corporation enters into its own contracts. Another assumption is the corporation’s assets, and not those of its shareholders, are required to pay any judgments against the corporation. Well, not always!
The corporate structure is legitimately used by many people to manage their risk. A legal entity is created to conduct business, which includes contracting with customers and suppliers, and in turn, incurring debt. This structure shields the owner from liabilities and limits their exposure. However, plaintiffs asserting claims against an entity often seek to disregard the corporate form and hold the owners, members, and shareholders personally liable. This type of claim is commonly called, “piercing the corporate veil.”
Why Pierce the Corporate Veil?
The answer is simple.
Plaintiffs have recourse to pierce the veil and go after individuals and/or the parent company when it is believed owners are simply using their legal entity as their personal bank account and not observing appropriate corporate formalities.
Corporate formalities include:
- Scheduling and conducting annual meetings of owners and shareholders
- Documenting important decisions, known as “minutes”, made at meetings
- Defining a corporation’s purpose, how it will operate, and the duties of those who own it and manage it, known as “bylaws”
- Ensuring owners and management abide by those bylaws
For international business owners, a plaintiff may also seek to pierce the corporate veil to obtain jurisdiction over a parent company not present in the US, or does not do business within the U.S. Without personal authority over a parent company, any decision by a court would most likely be unenforceable against the parent. Therefore, a plaintiff may attempt to establish jurisdiction over the non-resident parent. They can do so by arguing that the corporate form of the subsidiary should be disregarded. This would make the parent company responsible for the subsidiary’s actions, which then establishes the court’s personal jurisdiction over the parent.
Alter Ego. The basis for Piercing the Corporate Veil
Courts will look at the structural relationship between the owners and the company when determining if the corporate veil will be pierced. In order to attribute the actions and jurisdictional contacts to the owners, a plaintiff must convince the court the owner is not separate from the company, that the entity is just an “Alter Ego.”
Courts generally focus on factors demonstrating how owners ignored the company’s separate identity and operated it as if they were one and the same.
Some factors commonly considered by courts when examining the alter ego theory include whether:
- The owners own all of the stock in the company
- The company is inadequately capitalized
- The corporate formalities are not observed
- The company fails to pay dividends
- The company makes undocumented “loans” to the owners or extends credit to the owners on other than market terms
- The owner’s bank accounts and telephone numbers are the same as the company
- The subsidiary functions as a mere façade of the parent company
This list of factors is not exhaustive.
How to Protect Yourself
To help lower the risk that a court will pierce the corporate veil to reach you personally, take the following steps:
- Properly capitalizing and ensuring the company
- Complying with corporate formalities, including the proper issuance of all stock certificates
- Properly filing the articles of incorporation
- Creating a separate and independent bank account for the company
- Fully documenting all transfers of money or other property between the company and the owners
- Ensuring all transactions with the company are on an arms-length basis, including any loan to or from the owners
We Can Help
The attorneys at Bridge Law LLP are expert in the areas of business formation and incorporation, and business litigation. The types of businesses include domestic businesses as well as international businesses looking to be established in the U.S.
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*The information presented in this article does not constitute legal advice, an attorney-client relationship, nor tax advice.