“Piercing the Corporate Veil” is a well-known phrase. To the average American, it conjures up visions of corporate giants being slain by David. This pejorative understanding has little practical value in today’s business world. In fact, “piercing the corporate veil” (holding the principals of a corporation or limited liability company liable for the debts of the company) is an all too real legal principle for entrepreneurs concerned with protecting their personal assets from the liabilities of their business. Incorporation law has developed to encourage business development and risk taking. Limiting owner liability (whether of individual owners or of parent companies) furthers this goal. However, there are limitations to the protections provided. First, it’s important that companies fully comply with the legal formalities required to maintain their business entity to ensure personal insulation. Second, the corporate veil may be pierced where one forms a corporation or LLC for the purpose of insulating personal assets, insulating the assets of another business or for some other unjust purpose.
In California, courts will pierce the corporate veil when two requirements are met: 1) the Court finds unity of interests (the shareholders, or owners in the case of an LLC, treat the corporation as an alter ego) – this happens when shareholders treat the assets of the corporation or LLC as their own and/or use corporate funds to pay their private debts; and 2) the Court finds that allowing shareholders to dodge personal liability would sanction fraud or promote injustice.
To answer these questions, courts look at numerous factors including: whether the shareholders/owners acted in bad faith; whether individual contracts were entered into with the intent of avoiding performance and hiding behind a corporate shield; whether assets have been diverted to the detriment of creditors; whether there is ownership and control of the entity by a few key individuals; whether the shareholders/owners and the corporation share the same office or business location; whether the shareholders/owners and the corporation share the same attorney; whether the shareholders/owners used the entity to procure labor, services and merchandise for others; whether the entity was adequately capitalized; whether corporate formalities were followed; and whether the result would be unjust should the court fail to pierce the corporate veil.
While California courts are generally reluctant to pierce the corporate veil, they are not afraid to apply the theory where the above factors evidence injustice. Entity shareholders and owners unsure about their personal protections should consult a business attorney.