As a sole proprietor, an owner’s assets are wholly at risk of seizure to satisfy company debts. To protect their personal assets, many small business owners choose to create a corporation or other separate entity to do business rather than assume the risk they may be personally liable for their company’s debts.
However, where an individual or individuals have not properly created a separate entity, courts can use the law of “alter ego” to “pierce” a company’s corporate veil and reach the owner’s assets to satisfy company debts. Piercing the corporate veil means that a creditor can reach the homes, bank accounts, investments, and other assets of the owners/shareholders to satisfy a business liability. This most often happens with closely held corporations and small LLC’s–in other words: small business owners.
Courts often justify this result where there is evidence of fraud or other wrongdoing by the company, so that a victim will be compensated for the wrongdoing by the company/owner. “The essence of the alter ego doctrine is that justice be done.” Mesler v. Bragg Management Co. (1985) 39 Cal.3d 290, 301.
Even absent evidence of fraud, California courts have found owners/shareholders liable where there has been commingling of corporate and personal funds, where a company has failed to observe corporate formalities including maintaining corporate minutes, or in the event a business has not been adequately funded. Associated Vendors, Inc v. Oakland Meat Co. (1962) 210 CalApp.2d 825.
Because of this potential for personal liability, it is imperative that small businesses retain legal professionals to guide them in complying with corporate formalities and recommended best practices in order to minimize the risk to their personal assets. The San Diego business attorneys at Gehres Law Library would be happy to provide you with additional information about these risks. Contact us anytime for a free evaluation.