Entrepreneurs generally form a corporation as a means of protecting personal assets. For example, corporate entities can protect the entrepreneur’s personal assets from plaintiffs who win a judgment against the company. Corporate entities foster business growth and expansion by protecting the individuals who actually run the company. Sometimes, however, a court permits a plaintiff to “pierce the corporate veil” of a corporation to obtain a judgment against the owners (i.e. founder(s) of the company, corporate officers or stockholders) personally. Entrepreneurs who start and incorporate their business should closely observe the corporate formalities. Otherwise, a plaintiff can invalidate the protections provided by the corporate form and obtain a judgment against the individuals. Startup Company Counsel advises startups on maintenance of the corporate formalities and preservation of the protections afforded by the corporate form.
In California, corporate entities are distinct and separate from the people who own them. A court will not permit a person to cast aside the corporate form unless justice so requires. Thus, unless a plaintiff proves that denying the plaintiff’s request to pierce the corporate veil will cause an injustice to the plaintiff, the court must permit the corporation to remain distinct and apart from its owners.
Piercing the corporate veil is also known as the “alter ego theory.” This theory applies to imposing liability on individual owners. Whether it is individuals and a corporation or two different corporations, California courts permit a plaintiff to pierce the corporate veil when the corporation and individual in question are so closely tied together that there is no distinction. The closely-knit relationship between corporate form and individual is called “unity of interest.” Additionally, courts must examine the potential result. Courts permit plaintiff’s recovery on an alter-ego theory if allowing the corporation to incur liability alone causes an injustice to the plaintiff.
Courts examine many variables when considering whether the corporation and individual share a unity of interest. Courts look for evidence of “commingling of assets” (failing to maintain funds separately among corporations and individuals) or whether an individual uses the corporate assets for personal use. Additionally, courts look for evidence of the corporation maintaining the formalities required by California corporate law, such as holding shareholder’s meetings, keeping adequate and accurate corporate records, and recording minutes from meetings. Courts look at many other factors as well, and no one factor or a combination of factors is dispositive.
Once the court determines the case presents a unity of interest, then the analysis turns on the relative justice to the plaintiff, resulting in the court either denying or granting the plaintiff’s request to attach the alter ego. Courts allow plaintiffs to pierce the corporate veil when the owners of the entity used the “corporate form” to perpetrate a fraud, avoid a lawful obligation, or pursue an inequitable cause. Plaintiffs need not prove the corporation committed actual fraud on them. Rather, the idea is to prevent the corporation from using the corporate form in bad faith. The alter-ego theory is not a means to satisfy a plaintiff who cannot recover a judgment – California courts require a more unjust result than that.
California Startup Corporations Must Maintain Separate Identities
Courts will not impose liability on an individual owner of a corporation if the corporation maintains its separate legal identity. While incorporating a business may be a great way to protect the personal assets of the business owner, it can be a very tedious process. Startup Company Counsel advises business owners on how to form and maintain the corporate form and observe corporate formalities. Call Startup Company Counsel today at 408-441-7555 today to learn how our experienced California corporate attorneys can help your business.