What Does The Legal Doctrine Of Alter Ego Allow The Courts To Do If They Determine That The Company Is The Alter Ego Of Its Owner?
First, a little bit of history: Way back in, let’s say, the 19th century, there was no concept of an alter ego. Let’s say you were a passenger in a stagecoach. If your stagecoach broke apart while you were in it and you were injured, your remedy would be to go after the stagecoach company. If they had no money or were headquartered somewhere out of state or overseas and you couldn’t find any assets, it was tough luck in the old system.
The first major case that dealt with alter ego in California involved a public swimming pool. (You may have one of those public swimming pools nearby, though many of them have been drained and are now closed..) For a few dollars, you and your children could go swimming, and the pools would have a lifeguard on duty. The public swimming pool in the case was privately owned, rather than being operated by a public park. Someone went to the swimming pool and drowned. It turned out there was no lifeguard on duty that day. The victim’s family sued the company that owned the public swimming pool, but the owner of that company said they were out of luck; he didn’t have insurance, and the company didn’t have any assets. Basically, condolences to your family, but you get nothing. The courts viewed this situation as an injustice.
The idea of allowing people to get their money together, maybe two or three or four investors, to form a company, to operate a business, to earn a profit, to employ people, etc. is a privilege granted by each state. The law came up with a doctrine that said, yes, you have the privilege to form corporations, but you need to adequately capitalize, to put in enough money. If there’s not enough money, you need to buy insurance to protect against predictable kinds of risks. If you operate a swimming pool company, people are going to drown. If you operate a rollercoaster, it might, at some point, go off the rails and injure people. Alter ego liability was fashioned for those circumstances where there is no money left in the company or the owners are broke and, for whatever reason, didn’t buy insurance. The courts believe it would be a great injustice to allow the defendant to get away with paying nothing; and therefore, under this doctrine of alter ego, they allow the family of the person injured or killed to go past the corporation’s assets and reach into the personal assets of officers, directors, or shareholders.
In California, there are tests to determine whether alter ego should apply. Generally speaking, it would be considered a serious injustice if an incident was foreseeable due to the kind of risk that has been undertaken. Let’s look at a food company that produces cheese. Customers eat the cheese, get sick, and die. Then, it turns out the cheese had Listeria or E. coli or another type of bacteria that can kill people. Contamination is a foreseeable risk, and if the food company has decided not to purchase insurance to cover what we refer to as product liability, that’s a situation where courts will often fashion an alter ego remedy to go past the assets of the company to the assets of officers, directors, or shareholders.
In cases involving a big company that has a subsidiary (a small company that’s part of all of their various tentacles and arms) making products and trying to earn profits, the courts might fashion a remedy that allows the people suing for injury to go past the assets of the subsidiary and to attack or reach assets of the parent company.
Under What Circumstances Can Courts Disregard The Corporate Structure And Hold Shareholders Liable For The Debt Of A Corporation?
There are many circumstances wherein courts could hold shareholders liable. The example of the cheese company that didn’t purchase insurance, selling products in the market that make people get sick and die, would apply here. Another example would be a company that has a licensed drug on the market, but it turns out that company provided false data to the FDA in order to get their product approved and available for sale. Any circumstance that smacks of injustice—not buying insurance, getting away with a scam, failing to comply with licensing—will lend itself to an alter ego situation. Some companies will even transfer all of their cash out of a company in advance of a lawsuit or a trial. Judges will make their determination based on the evidence of injustice.
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