Collecting from Stockholders of Shell Corporations:Piercing The Corporate Veil under the Alter Ego Doctrine
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Collecting from Stockholders of Shell Corporations:Piercing The Corporate Veil under the Alter Ego Doctrine

Tuesday, January 12, 2010By Richard Alexander

Being a personal injury lawyer is not as simple or easy as some falsely believe.  Piercing a shell corporation in order to collect directly from its shareholders is a case in point. 

Personal injury attorneys encounter shell corporations created simply to minimize liability and avoid legal responsibility for personal injuries and wrongful deaths.  When that occurs it is necessary to do what is known under the law as “piercing the corporate veil” and establishing that the corporation is the “alter ego” of the stockholders, in order to collect directly from outlaw owners.

Shell corporations can be encountered in any personal injury and wrongful death case.  We have seen them in cases arising from construction sites where the general contractor or sub-contractor operates under a shell corporation or through subsidiaries.

In cases of birth defects caused by exposure to toxic chemicals during pregnancy, manufacturers will be found to have used under capitalized subsidiaries to avoid paying damages to children with lifetime malformations of the brain, eyes, skeleton, kidney, heart and other internal organs.

Under California law, owners of a corporation are insulated from personal liability caused by the corporation, or a subsidiary corporation, providing the corporation has been operated in a lawful manner.  When that happens any recovery against the corporation is limited to the assets of the corporation.

But when a corporation has not operated according to law, the stockholders can be held personally liable for negligence, reckless and intentional misconduct committed by the officers, agents or employees of the corporation.

Shareholders or a parent corporation will be held personally liable for corporate wrongs providing two issues can be proven:  (1) whether there is such a unity of interest and ownership that the separate personalities of the subsidiary and the parent corporation, or the corporation and its shareholders, no longer exist, and (2) whether an inequitable result will follow if the acts are treated as those of the subsidiary or the corporation alone.  Automotriz del Golfo de California S. A. de C. V. v. Resnick, 47 Cal. 2d 792, 796 (1957).

The alter ego doctrine is founded on equitable principals and aims to limit the exercise of the corporate privilege to prevent its abuse.  As stated by the California Supreme Court:

The issue is not so much whether for all purposes, the corporation is the "alter ego" of its stockholders or officers, nor whether the very purpose of the organization of the corporation was to defraud the individual who is now in court complaining, as it is an issue of whether in the particular case presented and for the purposes of such case justice and equity can best be accomplished and fraud and unfairness defeated by a disregard of the distinct entity of the corporate form.

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The essence of the alter ego doctrine is that justice be done.  "What the formula comes down to, once shorn of verbiage about control, instrumentality, agency, and corporate entity, is that liability is imposed to reach an equitable result."   [Citation omitted.]  Thus the corporate form will be disregarded only in narrowly defined circumstances and only when the ends of justice so require.

Mesler v. Bragg Management Co., 39 Cal. 3d 290, 300-301, 216 Cal. Rptr. 443, 448 (1985).

The most comprehensive discussion of the factors courts consider in their analysis of whether to pierce the corporate veil is in a California Appellate Court case, Associated Vendors. Inc. v. Oakland Meat Co., 210 Cal. App. 2d 825. 838. 26 Cal. Rptr 806 (1962).

The court in Associated Vendors conducted a review of California veil-piercing cases and identified a variety of factors which were pertinent to the courts’ determination of whether to pierce the corporate veil under the particular circumstances of each case.

These factors, in some instances, combine both the control and equity prongs of the Automotriz test.

Although there is no guidance as to which combinations are compelling or which factors weigh most heavily with California courts, in every case several of the factors noted below were present.

The factors listed by the Associated Vendors’ include:

(1)        Commingling of funds and other assets, failure to segregate funds of the separate entities, and the unauthorized diversion of corporate funds or assets to other than     corporate uses.

(2)        The treatment by an individual of the assets of the corporation as his own.

(3)        The failure to obtain authority to issue stock or to subscribe to or issue the same.

(4)        The holding out by an individual that he is personally liable for the debts of the     corporation.

(5)        The failure to maintain minutes or adequate corporate records, and the confusion   of the records of the separate entities.

(6)        The identical equitable ownership in the two entities; the identification of the equitable owners thereof with the domination and control of the two entities;   identification of the directors and officers of the two entities in the responsible supervision and management; sole ownership of all the stock in a corporation by one individual or the members of a family.

(7)        The use of the same office or business locations the employment of the same employees and/or attorney.

(8)        The failure to adequately capitalize a corporation; the total absence of corporate assets, and undercapitalization.

(9)        The use of a corporation as mere shell, instrumentality or conduit for a single venture or the business of an individual or another corporation.

(10)      The concealment and misrepresentation of the identity of the responsible    ownership, management and financial interest, or concealment of personal             business activities.

(11)      The disregard of legal formalities and the failure to maintain arm’s-length   relationships among related entities.

(12)      The use of the corporate entity to procure labor, services or merchandise for another person or entity.

(13)      The diversion of assets from a corporation by or to a stockholder or other person    or entity, to the detriment of creditors, or the manipulation of assets and liabilities between entities so as to concentrate the assets in one and the liabilities in  another.

(14)      The contracting with another with intent to avoid performance by use of a corporate entity as a shield against personal liability, or the use of a corporation as a subterfuge of illegal transactions.

(15)      The formation and use of a corporation to transfer to it the existing liability of  another person or entity.

Whether the corporate veil should be pierced in any given fact situation will depend upon the circumstances of each case.  Mesler, 39 Cal. 3d at 300.  The analysis of the issue is a question for the trier of fact.  H.A.S. Loan Service. Inc. v. McColgan, 21 Cal. 2d 518, 524 (1943); Las Palmas Assoc. v. Las Palmas Center, 235 Cal. App. 3d 1220, 1248, 1 Cal. Rptr. 2d 301, 317 (1991); Farenbaugh & Son v. Belmont Construction, Inc., 194 Cal. App. 3d 1023, 1032, 240 Cal. Rptr. 78 (1987).

In addition, because the doctrine is founded upon equitable principles, prior decisions involving factual situations which evidence similar types or amounts of control or commingling are of limited persuasive value as the trier of fact must be convinced of the inequity in each case.  Las Palmas Assoc, 235 Cal. App. 3d at 1248, citing McLoughlin v. L. Bloom Sons Co. Inc., 206 Cal. App. 2d at 853.

A court still may resolve the issue on demurrer at the pleading stage if the court finds that, as a matter of law, plaintiffs allegations, even if proved, would be insufficient to support a finding of alter ego.  See Dos Pueblos Ranch & Improv. Co. v. Ellis, 8 Cal. 2d 617 (1937) (allegations showing that individual owned majority of stock and controlled, dominated and managed corporation were "woefully inadequate"); Sheard v. Superior Court of Alameda County, 40 Cal. App. 3d 207, 211-212, 114 Cal. Rptr. 743 (1974) (motion to quash granted where complaint contained no alter ego allegations and affidavit submitted in opposition to defendant’s affidavit, which demonstrated no contact with state, failed to set forth facts showing alter ego relationship); Norins Realty Co. v. Consol. A. & T. G. Co., 80 Cal. App. 2d 879, 882-883, (1947) (allegations of complaint insufficient where plaintiff merely alleged that corporation was alter ego of individual stockholders): but cf First Western Bank & Trust Co. v. Bookasta, 267 Cal. App. 2d 910, 915-916, 73 Cal. Rptr. 657 (1968) (judgment of reversal after demurrer sustained reversed as to alter ego allegations as allegations sufficient to state a cause of action and plaintiff entitled opportunity to present evidence in support of facts alleged); Minifie v. Rowley, 187 Cal.481 (1921) (judgment reversed and court ordered to enter order overruling demurrers as allegations sufficient).

Individual case analysis provides an insight into how courts weigh the factors identified in Associated Vendors and balance the equities or inequities of the particular circumstances in each case.

There are no simple answers in this area of the law.

When a court is not convinced that inequity will result if the corporate form is respected or the court is not convinced that the alleged alter ego entity is guilty of any "bad acts," one court will disregard facts which under different circumstances another court would point to as evidencing dominion and control.

Personal injury attorneys need to identify these issues and know this narrow field of law, when lifetime damage has been inflicted by corporate shareholders operating behind a shell corporation.

Onward,

Richard Alexander

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