What’s behind the veil?: Digging for the truth in alter-ego cases

In many cases, shareholders in a corporation can fully protect themselves against liability for corporate debts. After all, the protection of the corporate form isn’t just for successful businesses and can’t be discarded simply because poor management or unavoidable losses depleted the company’s assets.

So when a plaintiff can’t collect a judgment from a corporation and seeks to obtain it from the corporation’s owners, it must convince the court to “pierce the corporate veil.” To do so, the plaintiff must show that the shareholders abused the corporate structure in such a way that it would be unfair to let them hide behind it. Typically, this means showing that the corporation and its shareholders lack separate identities — that is, the corporation is the owners’ alter ego.

Lack of separateness

Lack of separateness is a key factor in alter-ego cases. A court is more likely to disregard the corporate form if the shareholders themselves disregarded the corporation’s separate existence. For example, if the shareholders neglected corporate formalities — such as electing officers and directors and keeping minutes — the corporation might be an alter ego. In addition, commingling of funds and assets can blur the distinctions between a corporation and its shareholders.

Lack of separateness also can be an issue when a parent corporation has one or more corporate subsidiaries. Plaintiffs who dealt with a subsidiary may have believed they were dealing with the parent. The corporations may have been so similar that it was difficult to tell them apart. Or the parent’s actions or representations may have led the plaintiff to believe that the parent would stand behind the subsidiary’s obligations.

Similarities between a parent and subsidiary can create confusion and support application of the alter-ego doctrine. Entities may not be separate, for example, when they share the same, or a similar, line of business, name or trademark. Moreover, if they share officers or directors, they might not be considered separate.

Lack of separateness also may be indicated by transactions between a corporation and its shareholders or parent that aren’t conducted at arm’s length. For example, the parent might sell or lease property for less than fair market value.

A financial expert can provide insight into whether such situations are ordinary and appropriate or indicate abuse.

Financial dependence

A common sign that a corporation has an alter-ego relationship is when it’s financially dependent on its shareholders or parent. This relationship is often demonstrated when the corporation is undercapitalized, the shareholders or parent owns most of the assets used in the business and leases them to the corporation, or the shareholders or parent makes undocumented or below-market loans to the corporation or relieves the corporation from its payment obligations.

A financial expert can analyze the corporation’s capital structure and compare key financial ratios and indicators to similar companies to determine whether it’s undercapitalized. The expert also may review the corporation’s operating history and analyze intercompany transactions and relationships to determine whether the corporation became undercapitalized as a result of operating losses or irregularities in its financing. In addition, the expert can analyze transactions to determine whether they were conducted on an arm’s-length basis.

Undue influence

Nothing says “alter ego” like shareholders or a parent that exercises undue influence or dominates a corporation. In this case, the shareholders or parent may cause the corporation to favor it over third parties (by, for example, giving it a preferred status over other creditors).

In such cases, a financial expert can review the corporation’s operations and transactions, examine accounting records and apply valuation techniques to determine whether the corporation’s dealings with related parties are legitimate or involve undue control or domination by its owners.

Piercing the corporate veil

Because there’s a lot at stake with alter-ego cases, make sure you work with an expert that fully understands not only how corporations work, but also how they sometimes hide certain assets and relationships through alter-ego entities. It’s time to pierce that corporate veil.