Alter Ego Doctrine
Normally, the corporation is an insulator from personal liability for shareholders and officers of a corporation from the claims of creditors. Limited liability for the persons involved in the corporation is a protection afforded by the corporate form and the privileges associated with the fictional entity created by statute and recognized by the state, and as such, the individual shareholders and officers are protected by the corporation from individual/personal liability and subject only to limited liability. However, there are occasions when the shield from liability afforded by the corporation will be denied, and instead the courts will look beyond the corporate form and deal with the substance of the transaction as if the corporation does not exist and render the shareholders and officers personally liable for acts and liabilities of the corporation. This is the alter ego doctrine.
The alter ego doctrine arises when a plaintiff comes into court claiming that the opposing party is using the corporate form unjustly and in a way that is harmful to the plaintiff’s interests. In certain circumstances, the court will disregard the corporation and hold the individual shareholders and officers liable for the actions of the corporation. Since the separate personality of the corporation is a statutory privilege, when it is abused, it will be disregarded and the corporation looked at as a collection or association of individuals, liable for the acts done in the name of the corporation. This is called “piercing the corporate veil” an equitable doctrine based on fairness, justice and public policy to impose liability on the individuals who disregard and abuse the corporate form. When a court disregards the corporate entity, the court does not dissolve the corporation, rather, the court disregards the fiction of the corporate entity or will pierce the corporate veil, thus disregarding the corporate privileges, and fastening liability on the individual shareholders.
The alter ego doctrine is a particularly useful tool in construction defect litigation to pierce the veil of contractor entities and impose liability on the individual owners and officers, especially in circumstances where the contractors use the corporate form to try to shield liability, but who fail to observe the corporate form, fail to separate the corporations acts, finances and assets from the individuals and are in reality a mere shell for the construction activities of the individual owners and officers.
There is no litmus test to determine when the corporate veil will be pierced, rather the application of the doctrine and the result will depend on the circumstances of each case. There are, nevertheless, two general requirements: (1) that there be a unity of interest and ownership that the separate personalities of the corporation and the individual(s) no longer exists, and (2) that, if the acts are treated as those of the corporation alone, an inequitable result will follow.
The 14 Factors to Test for Alter Ego Liability
The alter ego test encompasses a host of factors: Listed as follows:
- 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
- The treatment by an individual of the assets of the corporation as his own
- The failure to obtain authority to issue stock or to subscribe to or issue the same
- The holding out by an individual that he is personally liable for the debts of the corporation, the failure to maintain minutes or adequate corporate records, and the confusion of the records of the separate entities
- The identical equitable ownership in the two entities, the identification of the equitable owners with the domination and control of the two entities, identical directors and officers in separate entities responsible for supervision and management, sole ownership of all stock in a corporation by one individual or the same members of a family
- The use of the same office or business location, the employment of the same employees and/or attorney
- The failure to adequately capitalize the corporation, the total absence of corporate assets and undercapitalization
- The use of the corporation as a mere shell, instrumentality or conduit for a single venture
- The concealment and misrepresentation of the identity of the responsible ownership, management and financial interest, or concealment of personal business activities
- Disregard of the legal formalities and the failure to maintain arm’s length relationships among related entities
- The use of the corporate entity to procure labor, services or merchandise for another person or entity
- The diversion of assets and liabilities from a corporation by or to a shareholder 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
- The contracting with another with the intent to avoid performance by use of a corporate entity as a shield to personal liability
- The formation and use of a corporation to transfer the existing liability of another person or entity
Note: This list is not exhaustive and courts may consider other factors according to the circumstances of each case. No single factor is determinative and the courts will examine all of the circumstances to determine whether to apply the doctrine. In other words, these factors are critically important, and the issue of alter ego liability will depend on the facts and circumstances of each case.
Construction Contractors and Alter Ego Liability
General contractors and other construction contractors in California routinely form corporations and then just as routinely violate many of the factors listed above, commingling funds, disregarding the separateness of themselves from the entity and operating the corporation simply as an extension of themselves. In instances where the contractor has substantial personal assets and net worth, employing the alter ego doctrine is vital to expanding the resources for recovery and liability beyond the corporation, which in many cases, has no assets at all, and beyond insurance, which may only cover a very limited range of damages.
Norton & Associates: Litigating Alter Ego Liability against Contractors
For a consultation and evaluation of construction defect and alter ego claims, contact Timothy Norton of Norton & Associates today at (310) 706-4134 or click here to request a call back.