Piercing the Corporate Veil
Beware the Personal Guarantee is a common mantra among business owners. Business owners may hope for the best, but often plan for the worst by avoiding personal liability as much as possible and keeping personal assets insulated from business debts.
In an interesting bankruptcy case, a bankruptcy judge crossed the line between business and personal assets to permit a business investor to file a claim against the debtor as an individual, despite the debtor’s attempts to keep his personal assets out of reach.
In legal jargon, the practice is commonly referred to as piercing the corporate veil. It happens sometimes in circumstances where business owners or shareholders undertake actions that blur the line between business and personal interests. A court may find that the corporation is merely the “alter ego” of the shareholder. In other words, a shareholder who acts in the company’s name to promote his personal best interest may be found to be using the corporation as an alter ego, setting up a perfect scenario for a court to pierce the corporate veil and hold the shareholder personally liable.
Courts will look to see whether two primary elements coexist when deciding if a corporation is the alter ego of a shareholder:
1. Whether there is such a unity of interest and ownership that the separate entities of the corporation and the person (or subsidiary) are no longer distinguishable; and
2. Whether the result would offend common notions of equity if the acts of the shareholder were treated as acts of the corporation alone.
Factors the Court Considers:
In answering those two primary questions, courts may consider a number of factors, including the following:
- Whether corporate and shareholder funds were kept separate or commingled;
- Whether the corporation followed the usual formalities by maintaining minutes of corporate meetings and observing corporate bylaws in electing officers and taking other actions;
- Whether the corporation is adequately funded to be more than a shell or an instrumentality of the shareholder;
- Whether the corporation complied with applicable law;
- Whether the corporation issued stock to shareholders;
- Whether the corporation conducted all of its business in the corporate name, or whether it did so selectively;
- Whether the shareholder listed corporate assets on his or her personal financial statements.
In the particular case at hand, a Long Island bankruptcy judge decided that a limited liability company was merely the alter ego of an individual debtor and that the debtor used the LLC for illegitimate purposes. The judge held the debtor should not be permitted to insulate himself from the consequences of his fraudulent conduct, and allowed the investor to file a claim against the debtor personally.
As it turned out, the debtor used more than $340,000 of the investment funds for his personal expenses, including groceries, hotels, pet supplies, doctor bills, meals and entertainment, income tax, and 100% of the costs of operating the corporate office, yet he failed to turn out a movie of any sort.
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