When starting a business, an essential consideration is whether to create a separate legal entity, such as a corporation or a limited liability company (LLC). An important reason for establishing a separate legal entity is to potentially limit the personal liability exposure of the business’ owners. Typically, if the business becomes liable to any creditors, the business entity itself, and not the owners, would be liable
However, the law recognizes an exception to this general rule of limited liability in scenarios in which bad faith actions taken by the business or its owners lead to an unfair result for one of the business’ creditors. This exception is called “alter ego” liability and the act of holding an owner liable for the debts of the business is commonly referred to as “piercing the corporate veil.” In determining whether to apply alter ego doctrine, courts analyze a host of factors on a case-by-case basis. Some of the more common pitfalls that can lead to an application of the alter ego doctrine include:
(1) Failure to separate the assets of the business entity and the individual, including commingling personal and business funds and paying personal debts with business funds;
(2) Failure to adequately capitalize the business entity given the nature of the business; and
(3) Failure to follow corporate formalities, including maintaining records, holding required board or shareholder meetings, or appointing officers.
While this list is not exhaustive, nor is it possible to predict every scenario in which a court might apply the alter ego doctrine, the important takeaway is that limited liability is not absolute. A business entity must operate in a manner that respects the corporate form.
If you are sued as an alter ego of a company and want to speak to an experienced lawyer regarding your defense, please contact Park Lawless & Tremonti LLP for a free consultation. We have extensive experience representing clients throughout California in litigation involving claims of alter ego. Also, if you are forming a new company and want to speak to a lawyer about how to properly operate the legal entity to ensure that the limited liability protections are not inadvertently waived, you can also contact Park Lawless & Tremonti LLP for a free consultation.
© 2023 Park Lawless & Tremonti LLP. All rights are reserved. Attorney Advertising. This blog post is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.