The question for those creditors is this: Since there is so much overlap among the people involved and the activities of the two companies, will they eventually be paid from the assets of Go Fish or only from what is left of Fishing Ventures? The answer is, "it depends." Many factors that are discussed here can influence the result.
At some point in a corporation's decline toward too much debt, insolvency or bank-ruptcy, business owners see the proverbial "handwriting on the wall." For many, this starts as a desperate search for ways to preserve their corporation's remaining assets for their own benefit, instead of distributing them either voluntarily or through court order to the creditors to whom they right-fully belong. Some are tempted to employ strategies that serve their interests and not the creditors’.
Among these strategies is use of an "alter ego" scenario. Corporations are entities that are legally separate, both from their owners and shareholders and from other corporations. In certain circumstances, however, the separation may be breached and abused, most often resulting in not paying creditors. When there is this potentially fraudulent, non-separate relationship between two business entities or between a business and its owners or shareholders, the two can be considered "alter egos." For example, if owners use the business as their own personal piggy bank when the company is insolvent, then they may become liable for the company's corporate debts on the theory that they no longer had a separate legal identity from the company but that the two were actually "alter egos."
Diverting assets and hiding income and ownership are common alter ego scams. These scams are also found in tax evasion and other employee embezzlements. They may involve either actual or constructive fraud. The difference between the two centers around "proof of motive." In actual fraud, the perpetrators intend to use deception as the means for achieving a dishonest purpose (such as taking funds that rightfully belong to a creditor). With constructive fraud, motive is not the central issue. Constructive fraud is a breach of a legal or equitable duty regardless of motive that either takes place when the entity is insolvent or causes its insolvency. The challenge for creditors in these cases is to prove that the alter ego—whether an individual owner or officer or another company—is not a separate entity but is, in fact, another identity or manifestation of the debtor.
Most business owners choose to incorporate, primarily as a way to protect their personal assets from liabilities incurred by the business. The corporate form specifically exists for the very purpose of providing shareholders, officers, directors and other corporations with an insulating veil of protection from liability for a corporation's obligations. Shareholder liability is limited to the amount of capital that the shareholders invest in the corporation.
Courts are strongly predisposed not to upset the concept of the corporation as legally different from its officers, board or owners and from other corporations or business entities. They require substantial evidence to find that a creditor has the right "to pierce the corporate veil" and thus be held accountable for their misconduct persons or entities that controlled and misused the corporate form.
To pierce the corporate veil, a creditor or other plaintiff must demonstrate a lack of distinction between the debtor corporation and either (a) one or more individuals who own the corporation or (b) another entity (corporation) owned or controlled by the debtor corporation or by its owners. When there are sufficient factors of commonality, the two entities could have an alter ego relationship. Only when a court is satisfied by a preponderance of the evidence that there is a lack of sufficient separation between two entities and/or individuals will it allow the corporate veil to be pierced.
Breach of fiduciary duties is also looked at when the corporation is insolvent and the stockholders are in effect trustees for its creditors. Some court decisions set out a triple rule: first, that fiduciaries may not pursue an opportunity themselves if their corporation could do so; second, that the questions of whether the corporation could pursue the opportunity must be presented to the corporation; and third, if the fiduciaries actually use the assets of the business to develop the opportunity. Note that when a corporation's fiduciaries actually use corporate assets to pursue a business opportunity, i.e., the new entity, they implicitly assert that the project constitutes a corporate opportunity, and therefore the fiduciary is estopped from denying that the resulting opportunity belongs to the corporation. Any or all of these acts could also be factors in an alter ego analysis.
There are no bright-line rules as to when creditors may pierce the corporate veil. Courts look at all the circumstances and facts. Evidence that tends to persuade courts to allow the corporate veil to be pierced include:
- Company officials incurred corporate debt when it was known the company was insolvent.
- Shareholders took unreasonable sums from the corporation, which jeopardized its financial health.
- There had been general commingling of corporate funds or activities with those of one or more individuals who control the corporation.
- There had been no separation of the activities of the controlling shareholder and the activities of the business so that the business is only a facade for the shareholder's activities.
- Funds have been deposited to and withdrawn from the corporation for personal, rather than business, purposes.
- The two businesses share common office space, address and phone numbers.
- Dealings between the two corporations were not at arm's length, i.e., management fees accrued and never paid.
- There are substantially the same customers at roughly the same volume of business.
- There are substantially the same vendors at roughly the same volume of business.
- There is substantially the same management team structure in place in operating the business.
- There is access to and information related to the old business within the new business.
- Assumption of operating leases and related-party leases are taken on by the new entity.
- Purchase of assets by the new company from the old company takes place at an only slightly better than 'bargain purchase' type of transaction.
- Issues relating to 'breach of fiduciary duty,' 'duty of loyalty,' 'duty of care' and fiduciary duty to creditors all come into play.
Generally, a creditor will need to retain the services of an accountant to evaluate whether the two entities lack separateness and to present expert testimony to convince a trier of fact that the corporate veil should be pierced.
The alter ego doctrine exists to prevent individuals or corporations from misusing the protection of the corporate form to defraud creditors or engage in other unlawful conduct. Piercing the corporate veil to find an alter ego liable is rare, but it is a remedy that creditors may find necessary to pursue in certain circumstances.