Piercing The Veil – Alter Ego Doctrine

What Is Alter Ego Doctrine?

Alter ego doctrine is a legal circumstance used by the court to determine if a company and it’s owner or shareholders should be treated as one and the same entity instead of enforcing the protections that should normally be provided by the setup of an LLC or other such entity. It is absolutely the separateness that forms the basis for a separate entity and thereby the protections it should offer.

In What Circumstance Might This Issue Arise?

A lawsuit can create the circumstance in which a court is asked to delve into a companies finances in order to determine if the entity is actually separate from the owner of a business. Unpaid company vendors could potentially seek this if a company is unable to pay them and they seek to get to personal assets in order to recoup the money due them. Any lawsuit might potentially bring this issue up to the courts.

Another more personal issue that might delve into this section of the law is a divorce. When one spouse asks the court to review all company records looking to see if the finances of a company have been kept strictly separate or if there might be an avenue for them to gain more by having the courts “pierce the veil,” thereby removing all protections from the company and making it’s assets part of the divorce proceedings the same as all personal assets.

How To Maintain Separateness.

In order to maintain the separateness that constitutes the forming of an entity designed to separate business from personal finances it is very important to keep the finances separate. Depending on the type of entity you are dealing with, the owner should take draws or salary and pay all personal expenses from a personal account and business expenses from a business account.

I know it can at times be tempting to try to fudge a bit here and there but you must understand when you do these things what the risks are or could be. There are of course other risk having to do with taxes but we won’t go into those here. Divorces may be one of the issues that would arise for the majority when it comes to “Piercing the Veil”, but other circumstances like having under capitalized the business from the start or not following the rules in the state of setup when it comes to handling the business records could also bring this issue up in court.

Best practice should always be observed.

• Have a good bookkeeping regime.
• Keep company checking and other accounts separate from personal. Co-mingling of finances will be what the courts are looking for for alter ego doctrine.
• Take draws, salary, disbursements depending on the type of entity and pay all personal expenses from a personal account and business from business.
• Manage your finances trying not to take on more debt then you feel the company can manage.
• Keep whatever records, notes, meetings that may be required by the state of setup for your business entity.
• Ensure the business has adequate capital reserves for the debt you take on.