Most shareholders believe a corporation protects them from personal liability. This is generally true unless alter ego is successfully asserted.

Alter ego is an equitable claim that a corporation should be set aside in a lawsuit and the shareholders held personally liable for a debt. The theory was antiquated and rarely used. In recent years, it has seen a rebirth as many small business corporations are formed using cheap online services. While these services file the entity with the state, there is no real follow up or guidance in regard to how the entity is actually supposed to function. This, of course, leads to alter ego claims and disaster for the shareholders.

To prove alter ego, plaintiffs must paint a picture of misuse of the corporate entity by shareholders. There are many factors that can be looked at, but the following are commonly addressed:

1. Commingling of corporate and personal funds is very strong evidence against shareholders. The same goes for corporate and personal property.

2. Payment of shareholder debts by the corporate entity is another area ripe for examination. The classic situations that arise concern the corporation paying the mortgage or credit card debt of a shareholder. This can also lead to severe tax problems.

3. The failure to maintain corporate books is another problem area. Most cheap online services will send a number of blank forms along with the corporate filing, but most shareholders have no idea what to do with them and thus do nothing at all.

4. The failure to issue stock is another problem area. Stock certificates represent the ownership of the corporate entity. If stock is not issued, the corporation has no legal owners, which is a might bit hard to explain.

5. Failure to properly incorporate is another area that can be problematic. Every state has different rules, but many allow for the use of an incorporator. This is typically an attorney or the online service you might select. The issue that arises is how said incorporator transfers ownership to the shareholders. Some states, such as California, have fairly strong views on this subject. If done incorrectly, the transfer can lead to the odd situation where the shareholders are held not to be the owners of the corporation! It then gets very messy!

There are literally hundreds of other factors that can be looked at when it comes to evaluating whether a corporate entity should be set aside. The exact factors often depend upon the law in your state or whether you are being sued in federal court.

Whatever your situation, it is vital that you gain an understanding on how a corporation must be run and follow said guidelines. You are not “done” when you receive your corporate book in the mail. You are only beginning.

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