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Did We Just Pierce California’s Corporate Veil?

Just like most legal and non-legal topics, California strays from the nation when it comes to piercing the corporate veil. This article will be particularly important if you own or operate a corporation in California. Unlike the previous article on piercing the corporate veil, this will not focus on the parent company-subsidiary relationship. Instead, it will focus on piercing the corporate veil to get to the shareholders of the corporation. The article will explore how California’s alter ego theory differs, examples of circumstances California courts have found that pierce the veil, and the impact on shareholders when the corporate veil is pierced.

California’s Alter Ego Theory

As mentioned above, California’s alter ego theory differs from the general theory. In order to properly compare the two, it is important to understand ego theory elements:

  1. The shareholders dominate and control the corporation, disregarding the entity.
  2. An injustice or other wrong to a plaintiff will likely result if the corporate veil is not pierced.
    1. Generally, this can be accomplished by demonstrating fraudulent intent on behalf of the shareholders to avoid liability.

With the general alter ego theory restated, let’s explore how California’s alter ego theory is different from the general theory. As with the general theory, there are two elements, but in California both elements must be shown to pierce the corporate veil. They are:

  1. The corporation and its shareholders have a unity of interest with no real separate existence. (This is similar to the first element of the general alter ego theory. The real difference lies in the next element.)
  2. The corporation’s actions should be treated as the shareholder’s actions to avoid an inequitable result.
    1. Fraudulent intent on behalf of the shareholders is not required. Instead, California requires a demonstration that if the corporate structure was maintained, it would lead to an injustice or inequitable result.
      1. California’s standard can be demonstrated by either:
        1. An injustice flowing from treating the corporation and shareholders separately; or
        2. Wrongdoing or conduct amount to bad faith, making it inequitable for the shareholders to hide behind the corporate form.

Even though California courts have blazed their own path when it comes to the alter ego theory and its elements, the courts have not established a definitive set of facts that would cause a court to determine that the corporate veil has been pierced.

Examples of California Court Piercing Circumstances

It is because California courts have not established a definitive set of facts which would lead to a finding of piercing the corporate veil that California courts determine piercing claims on a case-by-case basis. In addition to not establishing a set of facts, California courts do not have a dispositive fact that would yield a court to find a piercing claim valid. Therefore, the best way to try to determine if a court may rule in favor of a piercing claim is to look at previous circumstances that have led the court to rule in favor of piercing:

  1. A single shareholder owning all of the corporation’s shares.
  2. A shareholder controlling the corporation.
  3. A shareholder using the same office or business location as the corporation.
  4. A corporation or shareholder concealing from the public that the shareholder is:
    1. Personally liable for the corporation’s debts;
    2. Using the corporation’s funds to pay the shareholder’s debts; or
    3. Otherwise using the corporation’s assets as the shareholder’s own.
  5. A corporation otherwise disregarding corporate formalities.
  6. A corporation and its shareholder having identical:
    1. Directors and officers;
    2. Legal counsel (representing both the shareholder and the corporation); or
    3. Employees or a combined payroll.
  7. Inadequate capitalization:
    1. Generally, CA courts do not use IC alone to pierce the corporate veil, thus why it is part of this list, but California courts have issued split decisions on whether this factor is dispositive.

If the above circumstances are shown by a party alleging piercing of the corporate veil, then there may be an adverse impact on shareholders. What are the impacts on shareholders? Read on and you’ll find out.

Piercing Impacts on Shareholders

When there is a finding of alter ego liability, the shareholders of a corporation are at risk of being tried. If this happens, the shareholders are treated as partners and are held jointly and severally liable. You may ask, how are they found as partners if there is a corporation? Remember, piercing the corporate veil basically alleges that shareholders are no different than the corporation and the corporate structure has been ignored. Thus, the shareholders are nothing more than partners. Therefore, each shareholder is subject to liability irrespective of the shareholder’s equity interest. This is a major reason why corporations should abide by all formalities and avoid any impropriety.

Is there any good news for shareholders in California if there is a finding of piercing the corporate veil? In California, the alter ego liability is generally limited to active shareholders. This means a shareholder must have participated in the behavior that led to the abuse of the corporate privilege. So, if you did not participate in the behavior, had no idea it was happening, and/or were blindsided by hearing the news, you may not be found liable. Also, if there were only a select few shareholders who directed and authorized the corporation’s wrongful conduct, then those shareholders will be held personally liable.

If your corporation is based in California, then you will want to make sure that it is abiding by the corporate structure, and there is a noticeable difference from its shareholders. This can be accomplished by proper incorporation, combined with continued corporate governance.

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