How Litigators Remove Liability Protection and Jeopardize Your Personal Assets – Orange County Small Business Lawyer

Are you concerned about your small business corporation being sued or losing liability protection in the event of a lawsuit? If you fail to maintain corporate formalities, you should be. Read this page to learn what litigators look for when they seek to strip you of the liability protections of your corporation in court. Discover how to protect yourself and your personal assets. Learn how an Orange County business lawyer can help.

alter-ego-theory-business-lawyer-orange-county-caIf you own a small business corporation in California, you’re well aware that your business might be sued. It’s probably one reason you incorporated your company in the first place – to protect your personal assets.

Unfortunately, some individuals incorporate a business in an attempt to secure their own protection while they defraud other parties. They believe they’re protected by the corporate veil. But the courts won’t tolerate this behavior. Therefore, alter ego theory exists to protect victims from this abuse.

What is the “corporate veil”?

The “corporate veil” is a legal term describing a separation between the rights and liabilities of a shareholder and their corporation. Because corporations are treated as a separate legal “person,” one benefit of incorporating a business is personal liability protection (in the event of a lawsuit, for example). To “pierce the corporate veil” means that a court treats the liabilities of a corporation as the liabilities of its shareholder(s). Learn more about piercing the corporate veil.

What is “alter ego” theory?

Alter ego theory means that no distinction exists between a shareholder and their corporation. They are, in legal fact, one and the same. Courts can invoke alter ego theory of personal liability when a corporation acts unjustly or fraudulently. It may be applied when a victim can’t receive fair compensation for damages caused by the corporation. This results in an unjust outcome, and the courts act accordingly to pierce the corporate veil.

Alter Ego Theory and Litigation against Small Business Corporations

Eager litigators know that some small business corporations avoid paying judgments against them by simply closing their doors. Therefore, if your company is sued, the plaintiff’s lawyers will look for ways to prove that you formed a business entity to protect yourself and that your corporation is invalid.

Specifically, a plaintiff’s attorney will look for evidence that your corporation is simply your alter ego. That means that there’s no separation between you and your corporation. It also means that your corporation could be deemed a sham by the courts. Once that’s established, the court can pierce the corporate veil and you can be held personally liable for the actions of your corporation. You could even be attached to an already existing judgment against your business.

Proving Alter Ego Theory

Alter Ego Theory - Business Attorney Orange CountyLitigators know that it’s easy to prove that a small business corporation is just an alter ego of the business owner. Just how easy it is depends on the separation kept between a business owner and her corporation. The plaintiff’s attorneys know exactly what to look for to prove that no distinction exists between you and your corporation. Some of the indicators they seek include the following:

  • Improper or incomplete formation of a corporate entity
  • Inadequate capitalization
  • Failure to maintain corporate records
  • Failure to submit required documents to the secretary of state annually
  • Commingling corporate and personal funds

Once one of these circumstances is established, the protective corporate shield may be stripped away. Then, your personal assets are up for grabs.

Adding a Business Owner to an Existing Judgment is Now Easier in California

The California Court of Appeal recently made it easier to add a business owner to an existing judgment against a limited liability partnership, corporation, or limited liability company (LLC). In Relentless Air Racing LLC v. Airborne Turbine Ltd Partnership (Dec. 31, 2013) 2d Civil No. B244612, the appellate court reversed the trial court’s conclusion specifying that the business owners could not be added to the judgment under the alter ego theory.

The appellate court, however, found that this decision led to “an inequitable result as a matter of law.” Airborne was insolvent and the plaintiff couldn’t collect the judgment from them. Therefore, the appellate court mandated adding the general and limited partners to the judgment. The business owners were held personally responsible to pay the judgment of about $180,000.

How can a business owner can be added as a judgment debtor?

To be added as a judgment debtor in California, a plaintiff must show that:

  1. The parties to be added as judgment debtors had control of the underlying litigation and were virtually represented in that proceeding;
  2. There is such a unity of interest and ownership that the separate personalities of the entity and the owners no longer exist; and
  3. An inequitable result will follow if the acts are treated as those of the entity alone. (Greenspan, supra, 191 Cal.App.4th at pp. 509, 511.)

While this situation might seem shocking, it’s completely preventable. The business owners in this case did little to protect themselves.

The most critical errors they made were ignoring corporate formalities and failing to maintain separation between themselves and their business entities. Among other things, they didn’t keep corporate records. They used corporate funds to pay personal bills. They also operated their businesses from home* using their personal equipment. Furthermore, they acknowledged their personal liability in court.

*Will I lose liability protection if I run my business from home?

If you run a corporation from your home, you should be diligent to maintain corporate formalities. Otherwise, you could be vulnerable. Contact an Orange County business lawyer to learn how to protect your corporation if you work from home.

Protecting the Validity of Your Business Entity and Your Personal Assets

Protect-Personal-Assets-Caliornia-Business-AttorneyIn Relentless Air Racing LLC v. Airborne Turbine Ltd Partnership, the plaintiff’s lawyers were able to prove that Airborne was simply an alter ego of its owners. The corporate liability protection was removed and the shareholders held personally responsible for the misdeeds of their corporation.

Fortunately, there are steps you can take now to protect your business and your personal assets. If you need help, contact an Orange County, CA small business attorney.

Start with a Properly Formed Corporation

These days anyone can form a corporation through an online service. While it’s perfectly legal to do so, it’s not a good idea. Incorporating a business is the practice of law, and there are several business entities to choose from. These do-it-yourself legal websites don’t allow you to discover what the best business structure is for your company.

Furthermore, you won’t get answers tailored to your specific business needs when you have questions. A “Frequently Asked Questions” (FAQ) page on a website simply isn’t enough to answer the detailed questions that arise when a business owner wants to form a corporation.

Many of these websites strongly recommend in their terms of use that if your situation is the least bit complicated, you should consult an attorney who specializes in handling small business matters – especially forming and maintaining corporate records for the business. Nothing is more complicated in forming a business entity that is intended to protect your personal assets. Not dotting all of the i’s and crossing all of the t’s can result in a critical failure of the protective device (corporate veil) when you need it the most.

Certain businesses, particularly those licensed by the state of California, require additional documentation and procedures that could be missed if you don’t consult a business lawyer. And, yes, hiring a corporate attorney will cost some money, but it will likely save you a substantial amount of money down the road. You’ll also get peace of mind knowing that your business entity is properly formed.

How to Properly Form a Corporation

Part of correctly forming a corporation involves completing a number of tasks after filing articles of incorporation. Many business owners skip some of the steps needed to form a corporation. These steps include the following:

  • Hold an initial Board of Directors meeting (or organizational meeting) and take minutes of that meeting
  • Elect officers and directors
  • Prepare and observe bylaws
  • Issue shares of stock
  • Adequately capitalize the corporation (see below)
  • Open an account with a business bank
  • Get appropriate insurance coverage for your business

If you skipped any of the above steps when incorporating your business, or if you’re not sure that your corporation was properly formed, contact a corporate attorney who works with small businesses. A lawyer can correct any errors made during incorporation.

Provide Sufficient Capitalization for Your Corporation

Corporate-Capitalization-Business-Lawyer-CaliforniaSomething else litigators look for when seeking to invalidate your business is under-capitalization. It may or may not be enough to prove the alter ego theory on its own. But coupled with other factors, like failure to maintain corporate records, it could help the plaintiffs pierce your corporate veil.

What Constitutes Sufficient Capital?

A business entity, like a corporation, limited partnership, or a limited liability company should be sufficiently capitalized when formed. What constitutes “sufficient capitalization”? Unfortunately, that can be a vague notion.

There is no specific amount required for courts to consider a business sufficiently capitalized. And it would be difficult to set an amount because of diverse requirements and expenses among different types of businesses. For example, in most instances, a commercial real estate investment firm would need more capital than an individual running a home-based word processing company.

While it can be difficult to come up with a specific amount to fund your business, common sense should prevail. A company should possess the funds necessary to at least cover its operating expenses for the foreseeable future.

One of the problems that small business owners have with sufficient capitalization is that they simply don’t start out with much money. We’ve all heard inspiring stories about companies that started out with very little money and then achieved great success. But when forming a business entity, it must be sufficiently capitalized from the beginning.

If you disregard providing sufficient capital for your company, you risk opening the door to litigators who seek to invalidate your corporation. Once the corporate veil is pierced, plaintiffs gain access to your personal assets. But you can avoid this problem by adequately funding your business from the start.

If you need advice about how to sufficiently capitalize your business, a corporate attorney can help.

Maintaining Corporate Records

Once a corporation is formed, you need to maintain corporate records, including the following documents:

  • Bylaws
  • Corporate minutes
  • Statements of information
  • A stock ledger
  • Financial statements
  • And more

These documents are required to lawfully run a corporation in California. The state mandates that these businesses hold annual shareholder meetings, regular board of director’s meetings as well as meetings of any existing committees of the board. Furthermore, minutes must be taken for these meetings.

Minutes of the annual shareholder meeting must be created every year. Additionally, these minutes should be updated when certain major corporate actions occur:

  • Opening a new bank account
  • Giving a salary increase to a key employee or an officer
  • Signing a new lease agreement

In many cases, small business owners avoid these corporate formalities for one reason or another. Typically, they feel that they lack the time to do so. Or they assume that because they own a small, closely-held corporation, they don’t really need to keep corporate records. But zealous litigators in a lawsuit will look for any evidence of failure to maintain corporate records. If they find it, you may be subject to the alter ego theory. Your corporation will then be invalidated, leaving your personal assets vulnerable.

Avoid Commingling Corporate and Personal Funds

In Relentless Air Racing LLC v. Airborne Turbine Ltd Partnership, the defendants frequently withdrew money from their businesses to pay personal debts. This muddied the waters and gave the plaintiff’s attorneys plenty of ammunition to prove the alter ego theory in that case.

Commingling corporate and personal funds demonstrates that no distinction exists between a business owner and her corporation. You can protect your business and personal assets by keeping your corporate and personal accounts separated.

That means that all corporate debts must be paid from corporate accounts. Likewise, personal bills should be paid only through personal funds or accounts, without exception.

If you hire employees, they must be paid through corporate accounts via corporate payroll or a payroll service. The appropriate deductions must also be made.

What about loans?

While making loans between a shareholder and the corporation is allowed, such loans must be properly authorized and documented. Failure to do so could put your corporation at risk if you’re sued.

Protect Yourself – Get Help When You Need It

If you haven’t maintained your corporate formalities for some time, you’re not alone. Some small business owners have avoided submitting their corporate records to the state for a very long time – even several years.

But, as you’ve just read, that can prove to be extremely hazardous if someone sues your corporation. You could even be named as a judgment debtor after a judgment has already been entered against your corporation.

Failure to maintain your corporate records is one of the main factors that the plaintiff’s attorneys could use to have your corporation invalidated by the court. Once that happens, the corporate veil is pierced and your personal assets – everything you’ve worked so hard for – become vulnerable.

Your plans for the future could be drastically changed. And just one lawsuit is all it takes.

This doesn’t have to happen to you.

Even if you haven’t maintained corporate formalities for some time, the G&V Corporate Records Program can help. If you own a California business, Orange County corporate attorney Andrew Gale can bring your corporate records current. Once they’re up-to-date, they can be maintained for a low monthly cost.

Designed with small business owners in mind, the Corporate Records Program is easy and affordable. So make sure your corporation remains strong and intact. It should afford you the tax benefits and the liability protections you expect. After all, liability protection is one of the reasons you chose to incorporate your business to start with.

Small Business Attorney Orange County - Get Help Today

Small Business Attorney Orange County – Get Help Today

Don’t wait until your business is sued!

If you’re behind on your corporate records, don’t hesitate any longer! Each day you put it off, you become more vulnerable to losing your personal assets in a lawsuit. To learn how the Corporate Records Program can help you, visit Shore up Your Corporate Fortress.

Better yet, call Andy today at (714) 634-4860!

Andy Gale can give you the peace of mind that comes from knowing your corporation is strong and your personal assets are well protected.

And when you call, be sure to ask about our “alter ego” audit.

The initial consultation is FREE and there is no obligation, so you have nothing to lose.

Call now or contact Orange County business lawyer Andy Gale today!

Also read:

4 Key Areas to Focus on to Protect Your Small Business Interests in California