Can A Shareholder Be Liable For Corporate Debt?

Although  the  personal  liability of shareholders  is  generally
limited   to  their  investment  in  a  corporation,  there   are
circumstances  under  which corporate  protection  from  personal
liability can be set aside by the courts.  The basis for  setting
aside such protection is known as the alter ego doctrine.

Under  the  doctrine of alter ego, the courts may  disregard  the
concept that a corporation's separate existence is distinct  from
that of its shareholders, and "pierce the corporate veil" thereby
exposing  the  shareholders to personal liability  for  corporate
debt.

There  are  two  requirements that must be met in order  for  the
courts  to  invoke The alter ego doctrine and create  shareholder
liability  for corporate debt.  These requirements  are,  in  the
words  of  the Court of Appeal in California, "(1) that there  be
such   unity   of  interest  and  ownership  that  the   separate
personalities  of  the corporation and the individual  no  longer
exist  and  (2)  that, if the acts are treated as  those  of  the
corporation alone, an inequitable result will follow."

In  an  action arising out of Alameda County some years ago,  the
Court  of Appeal enumerated a number of circumstances under which
a  trial  court could conclude that the disregard of a  corporate
entity  would  be  appropriate.  These  factors  were  listed  as
follows:

       1.     Commingling  of  funds  and  other  assets  in  the
unauthorized diversion of corporate funds or assets to other than
corporate uses.
          TRANSLATION:  You pay your home mortgage, utility bills
and gardener out of corporate funds.

      2.    The  failure to obtain authority to  issue  stock  or
actually issue stock.

           TRANSLATION:  You fail to file the appropriate  notice
with the Department of Corporations and also fail to prepare  and
sign the stock certificates.

      3.    The failure to maintain minutes or adequate corporate
records.

           TRANSLATION:  You haven't held or prepared minutes for
an  annual meetings of shareholders and directors in a decade and
haven't  documented  any  dealings which  have  occurred  between
shareholders and the corporation.

     4.   The failure to adequately capitalize a corporation.

           TRANSLATION:   You  formed your  corporation  with  an
initial capitalization of $12.


      5.   The diversion of assets from a corporation by or to  a
stockholder, to the detriment of creditors.

           TRANSLATION:  You owe $175,000 to creditors;  however,
you purchased the corporate Lear jet for what you consider to  be
good and adequate consideration, namely, the sum of $5.

      6.    The  use of a corporation as a subterfuge of  illegal
transactions.

          TRANSLATION:  You take bets for the Mob.

The  Court  of  Appeal concluded in the above  matter  that  "The
purpose  of  the  doctrine  is not to protect  every  unsatisfied
creditor, but rather to afford him protection, where some conduct
amounting to bad faith makes it inequitable . . . for the .  .  .
owner of a corporation to hide behind its corporate veil."

Many  owners  of  small businesses such as  coin  laundries,  dry
cleaners,  restaurants  and clothing stores,  form  corporations,
execute  leases  and purchase equipment under  the  name  of  the
corporation  and  assume  that they  are  protected  against  any
personal  liability.   Although many  pay  attention  to  ongoing
corporate responsibilities, others do not.  Those who fail to  do
so occasionally become subject to personal liability.

You   may  have  incorporated  by  the  filing  of  Articles   of
Incorporation with the Secretary of State and received  a  minute
book and stock certificate book from the attorney or agency which
provided the service, but you have not necessarily complied  with
all  of the requirements for corporate formation so as to protect
you from personal liability.

Corporate  obligations  frequently  overlooked  at  the  time  of
incorporation are the following:

      (1)   The  requirement that an appropriate notice be  filed
regarding the issuance of stock with the California Department of
Corporations;

       (2)    The  actual  preparation  and  execution  of  stock
certificates;

      (3)   The filing of any necessary Fictitious Business  Name
Statement.

      (4)  The preparation of minutes of the first meeting of the
Board of Directors which customarily includes many important
start-up resolutions.

There  are  occasions  when  an  individual  will  maintain   two
corporations, one with substantial assets and one which  operates
at  the poverty level.  The monied corporation will sometimes  be
deemed to be the alter ego of the impoverished corporation  under
the  alter  ego theory.  Courts look to the following factors  to
make such a determination:

      (1)  Whether there is identical, equitable ownership in the
two entities;

      (2)   Whether the same directors and officers  of  the  two
entities are responsible for supervision and management;

      (3)  Whether there is sole ownership of all of the stock in
a corporation by one individual or the members of a family;

      (4)   Whether  the  corporations use  the  same  office  or
business location;

      (5)  Whether the corporations employ the same employees and
attorney.

     The moral of the story?  Just because you own a minute book,
stock  certificate book and a corporate seal, doesn't  mean  that
your  corporate responsibilities are satisfied.  The  involvement
of  an  attorney  at  the  time of incorporation  and  an  annual
corporate  check-up by your lawyer may prove to be invaluable  in
protecting your assets, whether corporate or personal.

[This column is intended to provide general information only  and
is  not intended to provide specific legal advice; if you have  a
specific  question  regarding the  law,  you  should  contact  an
attorney  of your choice.  Suggestions for topics to be discussed
in this column are welcome.]


Reprinted from New Era Magazine
Myles M. Mattenson © 1999-2002