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Piercing the Corporate Veil in California

General Principles

The corporate law doctrine of limited liability insulates shareholders of a corporation from personal liability for debts incurred or torts committed by the firm. California was quite late in recognizing the limited liability doctrine. Indeed, up until 1931, when the relevant provisions were repealed, California’s constitution and statutes imposed personal liability on shareholders for their pro rata share of corporate debts and other obligations.[1] Even today, California is unusual in not recognizing the limited liability doctrine by statute. California case law, however, has accepted it.[2]

Alter Ego a.k.a. Piercing the Corporate Veil

The limited liability rule is subject to the equitable doctrine variously known as “piercing the corporate veil” or “alter ego.”[3] “The ‘veil’ of the ‘corporate fiction,’ or the ‘artificial personality’ of the corporation is ‘pierced,’ and the individual or corporate shareholder exposed to personal or corporate liability, as the case may be, when a court determines that the debt in question is not really a debt of the corporation, but ought, in fairness, to be viewed as a debt of the individual or corporate shareholder or shareholders.”[4] Or, as a seminal 1912 law review article put it: “When the conception of corporate entity is employed to defraud creditors, to evade an existing obligation, to circumvent a statute, to achieve or perpetuate monopoly, or to protect knavery or crime, the courts will draw aside the web [i.e., veil] of entity, will regard the corporate company as an association of live, up-and-doing, men and women shareholders, and will do justice between real persons.”[5]

Alter ego is a well-accepted principle in California law.[6] In developing the alter ego doctrine, California courts have balanced two competing considerations. On the one hand, they recognize “that the law permits the incorporation of businesses for the very purpose of isolating liabilities among separate entities. Since society recognizes the benefits of allowing persons and organizations to limit their business risks through incorporation, sound public policy dictates that disregard of those separate corporate entities be approached with caution.”[7] On the other hand, they have also emphasized that “it would be unjust to permit those who control companies to treat them as a single or a unitary enterprise and then assert their . . . separateness in order to commit frauds and other misdeeds with impunity.”[8] Indeed, perhaps because California was so late in recognizing the principle of limited liability, some commentators contend that “a perception [exists] that public policy in California favor[s] piercing the corporate veil.”[9] The empirical evidence tends to support this claim. Among the eight states with the largest number of reported veil piercing decisions, California courts have the highest rate (45%) of piercing the corporate veil.[10]

California courts have long required a plaintiff seeking to pierce the corporate veil to meet two requirements: “First, that the corporation is not only influenced and governed by that person, but that there is such a unity of interest and ownership that the individuality, or separateness, of the said person and corporation has ceased; second, that the facts are such that an adherence to the fiction of the separate existence of the corporation would, under the particular circumstances, sanction a fraud or promote injustice.”[11] As one California court wryly put it, this standard is “easy to state but difficult to apply.”[12]

In applying the alter ego standard, California courts have adopted a totality of the circumstances standard that includes an astonishingly large number of factors to be considered. As the leading precedent exhaustively explained:

A review of the cases which have discussed the problem discloses the consideration of a variety of factors which were pertinent to the trial court’s determination under the particular circumstances of each case. Among these are the following: Commingling of funds and other assets, failure to segregate funds of the separate entities, and the unauthorized diversion of corporate funds or assets to other than corporate uses; the treatment by an individual of the assets of the corporation as his own; the failure to obtain authority to issue stock or to subscribe to or issue the same; the holding out by an individual that he is personally liable for the debts of the corporation; the failure to maintain minutes or adequate corporate records, and the confusion of the records of the separate entities; the identical equitable ownership in the two entities; the identification of the equitable owners thereof with the domination and control of the two entities; identification of the directors and officers of the two entities in the responsible supervision and management; sole ownership of all of the stock in a corporation by one individual or the members of a family; the use of the same office or business location; the employment of the same employees and/or attorney; the failure to adequately capitalize a corporation; the total absence of corporate assets and undercapitalization; the use of a corporation as a mere shell, instrumentality or conduit for a single venture or the business of an individual or another corporation; the concealment and misrepresentation of the identity of the responsible ownership, management and financial interest, or concealment of personal business activities; the disregard of legal formalities and the failure to maintain arm’s length relationships among related entities; the use of the corporate entity to procure labor, services or merchandise for another person or entity; the diversion of assets from a corporation by or to a stockholder or other person or entity, to the detriment of creditors, or the manipulation of assets and liabilities between entities so as to concentrate the assets in one and the liabilities in another; the contracting with another with intent to avoid performance by use of a corporate entity as a shield against personal liability, or the use of a corporation as a subterfuge of illegal transactions; and the formation and use of a corporation to transfer to it the existing liability of another person or entity.[13]

The court gave little guidance as to how these factors should be weighted or balanced. It contented itself with merely observing that in all prior California cases in which the veil had been pierced “several of the factors mentioned were present.”[14] As the leading treatise on California corporate law opines of its standard, “it merely measures the rule by the length of the Chancellor’s foot.”[15] Nevertheless, the treatise further argues that, using the Associated Vendors factors as a template for the analysis, it is possible to provide “some guidance” as to whether veil piercing is appropriate in a given case.[16]

Enterprise Liability

Closely related to alter ego doctrine, but conceptually distinct from it, is the principle of enterprise liability. Properly understood, veil piercing is a vertical form of liability—it provides a mechanism for holding a shareholder personally liable for the corporation’s obligations. Enterprise liability provides a horizontal form of liability—it offers vehicle for holding the entire business enterprise liable. In other words, while the single business enterprise theory does not allow a plaintiff to reach a shareholder’s personal assets, if successfully invoked, enterprise liability does permit a creditor to reach the collective assets of all of the corporations making up the enterprise. And, of course, where both alter ego and enterprise liability are successfully invoked, the creditor will in fact be able to reach both the collective assets of the enterprise and the personal assets of its owners.

California unquestionably recognizes enterprise liability. In the leading precedent, Pan Pacific Sash & Door Co. v. Greendale Park, Inc.,[17] promoters of a real estate venture split the business into two corporations—one that owned the land and one that was to provide construction services. The land corporation had all the assets, while the construction company incurred all the debts. Plaintiff was a supplier who sold building materials to the construction corporation. When the debt was not paid, he attempted to reach the assets of the land corporation. The court allowed plaintiff to do so, holding that the land corporation was the alter ego of the construction company. Harold Marsh, the dean of California corporate lawyers, explained that the court thus used the alter ego doctrine to achieve an enterprise liability result.[18] Under Pan Pacific, the standard for invoking enterprise liability therefore requires a two-pronged showing: (1) such a high degree of unity of interest between the two entities that their separate existence had de facto ceased and (2) that treating the two entities as separate would promote injustice.[19] Among the grounds cited for imposing liability in Pan Pacific were: (1) both corporations were half of a single venture; (2) they had the same shareholders, directors, and officers; (3) they occupied the same premises; (4) they had common employees; and (5) neither was adequately capitalized.[20]

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[1] This history is traced in 2 Harold Marsh, Jr. & R. Roy Finkle, Marsh’s California Corporation Law § 16.13 (3d ed. 1991 supp.).

[2] See id. § 16.16 at 1390 (noting the “general rule is that the shareholders are not liable for the obligations of the corporation”).

[3] In the interests of candor, I should note that I have sharply criticized the veil piercing doctrine and even called for its abolition as to shareholders who are natural persons. (In contrast, I have advocated retaining the enterprise liability doctrine, discussed below, which uses veil piercing principles to impose joint and several liability on all firms that make up a single business enterprise.) See Stephen M. Bainbridge, Abolishing Veil Piercing, 26 Journal of Corporation Law 479 (2001). Obviously, my criticisms of the doctrine has been unavailing, as courts continue to routinely pierce the corporate veil. For purposes of this analysis, I have therefore taken the doctrine as I find it.

[4] Stephen B. Presser, Piercing the Corporate Veil § 1.01 at 1-6 (1991 and supp.) (footnotes and emphasis omitted).

[5] I. Maurice Wormser, Piercing the Veil of Corporate Entity, 12 Colum. L. Rev. 496, 517 (1912).

[6] See Moldo v. World Net Dev. Group, 2000 U.S. Dist. LEXIS 19092 at *20 (C.D. Cal. 2000) (noting that “California recognizes two types of alter ego claims, one that vests a right of action in an injured corporation, and another that belongs individually to corporate creditors ‘with a particularized injury.’”).

[7] Pacific Landmark Hotel, Ltd. v. Marriott Hotels, Inc., 19 Cal. App. 4th 615, 627 (1993) (citations omitted).

[8] Los Palmas Associates v. Los Palmas Center Associates, 235 Cal. App.3d 1220, 1249 (1992).

[9] Robert B. Thompson, Piercing the Corporate Veil: An Empirical Study, 76 Cornell. L. Rev. 1036, 1052 (1991).

[10] Id. at 1050.

[11] Minifie v. Rowley, 202 P. 673, 676 (Cal. 1921). Under this standard, the prospect of an unsatisfied claim is not enough to meet the latter prong of the test. Associated Vendors, Inc. v. Oakland Meat Co., Inc., 26 Cal. Rptr. 806, 816 (Cal. App. 1962) (“it is not sufficient to merely show that a creditor will remain unsatisfied if the corporate veil is not pierced”). Standing alone, incorporating a business to avoid personal liability neither promotes injustice nor sanctions a fraud. Instead, there must be some element of unjust enrichment. Sea-land Services, Inc. v. Pepper Source, 941 F.2d 519 (7th Cir. 1991).

[12] Talbot v. Fresno-Pacific Corp., 181 Cal. App. 2d 425, 432 (1960).

[13] Associated Vendors, Inc. v. Oakland Meat Co., 26 Cal. Rptr. 806, 813-15 (Cal. App. 1962) (citations omitted).

[14] Id. at 815.

[15] 2 Marsh & Finkle, supra note 1, § 16.16 at 1392.

[16] Id. at 1395.

[17] 333 P.2d 803 (Cal. App. 1958).

[18] See 2 Marsh & Finkle, supra note 1, at 1416 (“The Pan Pacific case may be considered to have adopted the so-called ‘enterprise entity theory’ . . . .”). See also Shelley M. Liberto, How to Avoid Debt by Reincorporating After Bankruptcy—Not!, Orange County Lawyer, September, 2002, available on Westlaw at 44-SEP Orange County Law. 18.

[19] See Las Palmas Assoc. v. Las Palmas Center Assoc., 235 Cal. App.4th 1220, 1250 (1991) (adopting Pan Pacific standard in an explicitly enterprise liability theory case).

[20] Pan Pacific, 333 P.2d at 806.