It might be argued that the American Dream—the opportunity and right to pursue prosperity and financial success—is based upon the corporate structure. To avoid much of the personal liability associated with running a business, an individual can form a corporation or limited liability company that is separate from the individual and that bears almost all the financial risk and responsibility. This model encourages individuals, after forming a business entity, to take risks, incur debts, make money, and possibly fail. If the company succeeds, the individual is compensated wonderfully. If the company fails, the individual can just let the company die, and the individual is usually insulated from any personal liability.
But are individuals who form corporations always insulated from personal liability? No, not always. This post briefly discusses the problems and risks associated with suing a company and how you can avoid the cut through the corporate shield and hold individuals personally responsible for the debts and liabilities of a corporate entity. This is done through an alter ego theory, also commonly known as “piercing the corporate veil.”
The Problem of Suing a Company
You enter a contract with a corporation. The corporation breaches the contract and causes you significant damages. So, you sue the corporation and spend thousands of dollars to successfully obtain a judgment against the company. But before you can collect the debt, the company goes out of business, leaving no assets to satisfy your judgment. To make things worse, you know the owners of the company are wealthy and have plenty of money to pay you off, but because they are hiding behind the corporate structure, they have no personal responsibility. In other words, you have essentially paid very good money to obtain a worthless piece of paper, which says you are owed a lot of money that you’ll never collect.
How do you get around this problem? At the outset, there are a few things you might want to consider. Perhaps you refuse to make deals with businesses only (especially those without a proven track record), requiring the business owners involved in any deal to sign a personal guaranty. Maybe you require other assurances, such as upfront payment or collateral to be used if the business doesn’t pay its obligations. But what if you are at the end of the deal, things have gone south, and you are stuck with an insolvent business that owes you a lot of money? One potential route is to pierce the corporate veil under an alter ego theory, as explained next.
Piercing the Corporate Veil
A corporation or limited liability company is generally separate and apart from its stockholders or members, and under America’s model of capitalism, this structure insulates these stockholders and members from personal liability—unless you can “pierce the corporate veil” and obtain a judgment against these people. To do so in Utah, you have to show that the company is acting as an alter ego of the individuals. It requires you to prove the “formalities requirement” and the “fairness requirement.”
The formalities requirement. To show this requirement, you must show a unity of interest and ownership that is so strong and pervasive that the separate personality of the business no longer exists—or should no longer be respected. There are many factors that can be used to make this showing, including the following:
- Undercapitalization of a one-man business
- Failure to observe corporate formalities, such as failure to keep detailed financial records and minutes of business meetings and decisions
- Failure to pay dividends
- Siphoning of business funds by the dominant stockholder or member
- Nonfunctioning of other officers, directors, or members
- Absence of business records
- Using the business structure as a facade for operations of the dominant stockholder(s) or member(s)
The fairness requirement. Meeting this requirement requires you to show that allowing the individuals who run the business to hide behind the corporate structure would sanction a fraud, promote injustice, or condone an inequitable result. You must do more than claim you will not get paid if the individuals behind the business entity are not held responsible. A main purpose of the corporate form is to shield individuals from this very type of personal liability, whether you consider this result just or unjust. You will probably need to show that the owners recklessly borrowed and lost money, engaged in business deals knowing full well that the business would not be able to pay its obligations, or somehow acted recklessly, dishonestly, or fraudulently.
Assistance with Lawsuits Against Businesses and Individuals
If you are considering suing a business run by individuals who have acted improperly, you may have a claim that these individuals are personally liable for their business’s conduct. Or, you may be an individual who owns a company and is being sued individually under an alter ego theory. Whatever the case, you would be wise to consult with a commercial litigation attorney.