One important attribute of a corporation is the limited liability of its shareholders. Normally, creditors of the corporation cannot reach its shareholders to satisfy corporate debts and liabilities. Nevertheless, there are circumstances under which courts will disregard the corporate form and hold its shareholders, as the owners of the business, personally liable for the debts and liabilities of the corporation. The theory for this action is variously referred to as the “alter ego doctrine,” “piercing the corporate veil,” or “disregarding the corporate entity.”
Situations in which the alter ego doctrine may apply include the following:
- Undercapitalization, that is, failure of the shareholders to fund the corporation with unencumbered capital reasonably adequate to cover its prospective liabilities;
- Failing to hold directors’ and shareholders’ meetings; failing to properly authorize and document corporate actions;
- Failing to keep corporate books separate from personal books; using corporate assets for personal purposes; commingling funds and other assets; lack of legal respect for the corporate existence;
- Domination of the affairs of the corporation by a single shareholder or group of shareholders acting in concert to improperly benefit their own interests; and
- Misleading others to believe that the shareholders will guaranty the obligations of the corporation, or misleading others to believe that they are dealing with the shareholders rather than the corporation.
In order to minimize the possibility that the alter ego doctrine will be applied, corporations should adhere to the following procedures:
- Fund the corporation with an initial amount of equity capital that is reasonably sufficient in light of its planned operations and commitments.
- Obtain and document required authorizations from shareholders and the Board of Directors (the “Board”) for corporate contracts and transactions.
- Maintain full and proper records for the corporation separate from personal records, including books of account, tax filings, minutes of directors’ and shareholders’ meetings, stock records, contracts, applications to and authorizations from legal authorities, etc.
- Maintain independent, arm’s-length relationships between the corporation and its principal shareholders. Ensure that transactions between the corporation and its principal shareholders, directors and officers are fully disclosed to the Board and to the shareholders and are expressly noted in the minutes. Ensure that such transactions are properly authorized by the Board and, if necessary, the shareholders.
- Clearly set forth in all contracts that contracting parties are dealing with the corporation, with any corporate representatives referencing themselves as officers or employees of the company, with appropriate titles as applicable. Cause all documents having legal effect to be signed by an officer of the corporation.
Tyler Shewey is a partner in the corporate law department at Berliner Cohen, LLP. He can be reached by telephone 408.286.5800 and via email email@example.com.