If you’re a business owner, you may have heard the concept of alter ego. As one of the most used concepts in business litigation, alter ego is used in court when a litigant, or accuser, tries to get past the protections of a corporate entity and directly assigns liabilities to the business owner. Corporations are viewed as separate from their owners under corporate law, so when an owner starts abusing their company for personal accounts, the company has essentially become the owner’s alter ego. This, then, opens owners up to personal liability cases, which can cost owners a tremendous amount of money.
To help you better understand how an alter ego can affect litigations against your company, here are the basics of corporate law and alter ego.
A Breakdown of Corporate Law
In the eyes of the law, a corporation and a limited liability company (LLC) are treated as distinct from their owners. As separate entities (and not alter egos), they can enter contracts, own assets, conduct business, and sue—in addition to being sued. Recent Supreme Court case rulings have even asserted that corporations have the freedom of speech rights.
Therefore, in the face of a lawsuit against the corporation or LLC, the company’s owners are protected from personal liability—by the “corporate veil.” The corporate veil, also known as the concept of limited liability, is essentially a shield standing between the company owners and the entity they control. It is what stops a business owner from losing their home and other personal assets when dealing with a lawsuit.
So, when a judge disregards the corporate protections to go after the corporate owner—or a subsidiary’s larger corporate owner, they are “piercing the corporate veil.”
Piercing the Corporate Veil
The corporation or LLC, wholly separate from its owners and operators, is often considered to be corporate fiction and can be easily negligible in a court of law. Notably, under certain circumstances, the court can pierce the corporate veil and acknowledge that there is not sufficient separation between the owner and the business entity.
However, acknowledging that there is no separation between an owner and their entity does not make the owner automatically liable. In order to assign personal liability, courts can look for evidence of other wrongdoing including:
- Inadequate capitalization
- Intermingling of business and finances of the company and the owner
- Alter ego
Inadequate capitalization alone is not enough to justify piercing the corporate veil, but when coupled with other reasons, courts have often pierced the veil.
Determining the Alter Ego
Alter ego derives from the situation in which the company is not its own entity but merely the alter ego of the owner*. To make a claim for alter ego under California law, a litigator would have to prove two key elements:
- Unity of Interests
The shareholders in question have treated the corporation as their “alter ego,” rather than as a separate entity; and
- Inequitable Result
Upholding the corporate entity and treating the acts of shareholders as those of the corporation in order to dodge personal liability for its debts would “sanction a fraud or promote injustice.”
*It should also be noted that an entity can be the alter ego of another entity—where Company A owns and operates Company B
If you’ve ever used your company for a personal expense, you have treated your company as an alter ego and opened yourself up to a personal liability. Prevent any potential litigations from affecting your business by keeping your corporation or LLC separate from yourself and your shareholders.
If you need assistance in determining how you or your business can navigate alter ego business litigations, please consult with your attorney or Hackler Flynn Associates.
DISCLAIMER: Content within this post should not be considered legal advice and is for informational purposes only. Communications made through this post do not create an attorney-client relationship. Hackler Flynn & Associates is not responsible for any content that you may access from third-party resources that may be accessed through or linked to this post. Hackler Flynn & Associates is only licensed to practice in California.
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