Alter Ego Doctrine
In business law, the alter ego doctrine is often used as justification for piercing the corporate veil and assigning personal liability upon a business owner. This happens when a judge finds that there is not sufficient separation between the owner and the business entity. In these cases, the company is not its own entity but merely the alter ego of the owner.
Separate Entities and Limited Liability
Both a corporation and an LLC are separate entities from their owners. In the eyes of the law, they have corporate personhood, which grants them some of the same rights as a human being, such as being able to enter into contracts, own assets, conduct business, sue and be sued, etc. Recent Supreme Court cases have even asserted that corporations have freedom of speech rights, just as a human being does.
When a lawsuit is brought against a corporation or LLC, the company’s owners are protected from personal liability. They are shielded, in legal terms, by the corporate veil, which stands between themselves and the entity they control. This protection is known as limited liability. It is what stops a business owner from losing their home and other personal assets in order to satisfy a lawsuit.
For example, say you purchase shares of stock in Microsoft. Good for you. You are now a partial owner of the company. If Microsoft is sued and found guilty for wrongdoing, however, a judge cannot order that you, a shareholder, must pay for the legal damages. You are protected by limited liability.
Disregarding the Corporation Fiction
Clearly a corporation or LLC is not a living, breathing thing. Thus, the idea of it being wholly separate from its owners and operators is a fiction. As well, the concept of a corporate veil between owners and their entity is but a novel metaphor.
Though it serves many functions, this corporate fiction may be disregarded in a court of law under certain circumstances. When this happens, the court acknowledges that there is no discernible difference between the entity and its owner.
Acknowledging that there is no separation between an owner and their entity does not, however, make the owner automatically liable. In order to assign personal liability, courts look for evidence of other wrongdoing.
In most cases, courts have invoked the following four reasons for piercing the corporate veil:
- Inadequate capitalization
- Intermingling of business and finances of the company and the owner
- Alter ego
In nearly every case, inadequate capitalization alone is not enough to justify piercing the corporate veil. However, when coupled with other reasons (especially fraud), courts have often pierced the veil.
Determining the Alter Ego
For a corporation or LLC to be ruled merely an alter ego of its owner, courts look at a variety of factors. It should be noted that an entity can be the alter ego of another entity, in cases in which Company A owns and operated Company B.
All of the following factors have been used to determine if the charge of alter ego applies:
- Gross under-capitalization
- Failure to observe corporate formalities
- Nonpayment of dividends
- Intermingling of personal and business funds
- Treatment by an individual of assets as if they were their own
- Siphoning of corporate funds by dominant corporation or shareholder
- Non-functioning officers and directors
- Absence of corporate records
- Corporation merely a facade for the dominate corporation or shareholder
Case Study: Keffer v. HK Porter Co., Inc.
In 1989 the US Court of Appeals ruled against HK Porter Co., Inc. and pierced the corporate veil, acknowledging that there was no substantial distinction between HK Porter Company (Porter) and its subsidiary, Connors Steel Company (Connors).
In 1950, Porter purchased Connors and incorporated the company as a wholly-owned subsidiary in 1974. Connors Retirees were offered health and life insurance benefits as part of a collective bargaining agreement. The agreement was renegotiated every three years.
An economic downturn caused Porter to close factories in 1982 and 1983. Retirees were informed that their benefits would terminate in 1984. The Retirees sued, claiming their agreement guaranteed benefits until they were eligible for Medicare.
Because Connors was bankrupt and could not pay its obligations, the Retirees argued that there was no distinction between Connors and its parent company, Porter. Thus, according to the Retirees, Porter was liable for paying the benefits.
In deciding to pierce the corporate veil, the Court of Appeals noted the following:
- Connors was at all relevant times acting as Porter’s “agent, alter ego and mere instrumentality”
- Porter’s sale of the insolvent assets of Connors and retention of $9 million in proceeds
- Porter’s Management and Control System which required Connors to get approval for all proposals and for any expenditure above $25,000
Making their ruling, the Court stated it would be “fundamentally unfair” for Porter to hide behind the separate existence of Connors in order to avoid liability.