Discussion:Commingling Funds (Business/Personal)

Is Your Company Your "Alter Ego"?

One of the most popular legal theories used by plaintiffs when trying to pierce the veil of a privately held corporation, or LLC, is "alter ego." Under this theory, the corporate veil is disregarded and the liabilities of the company become the liabilities of its owners. Nationally, if alter ego can be proven, the business owner will lose in court 96% of the time. Veil piercing cases using alter ego vary somewhat from state to state, but there appears to be a common test: (1) If it can be determined the separate personalities of the company and its owner(s) no longer exist, and (2) If the veil is NOT pierced then an inequitable or unjust result will follow. In addition, there is no clear method the jury can use to determine whether to pierce or not, making it an entirely subjective decision. Associated Vendors, Inc. v. Oakland Heat Co., 210 Cal. App. 2d 828, 838 (1962). Therefore, keeping the rules is critical. At Bulletproof Veil, we frequently see these compromising practices among business owners. The key to preventing or overcoming alter ego is knowledge and action: (1) knowledge of what you should be concerned about, (2) knowledge of how to remedy and avoid alter ego practices in the future, and (3) implementing this knowledge, thereby creating a stronger corporate veil. Over the course of the next several months we will discuss, in detail, the most frequently cited factors of alter ego liability and help you understand and avoid them. COMMINGLING Commingling is defined as the sharing or pooling of personal and business assets. This can occur in multiple ways between the owner and his/her company, or between multiple companies owned by the same individual(s). Although many business owners claim they never participate in commingling practices, we know otherwise. For example, it may be convenient for you to take a "loan" from the company, with the intent to pay it back. But you may have never bothered to formalize the loan with proper documentation creating an arms-length transaction. Take a hard look at your own company practices and procedures as you review this list of commingling activities: 1. Depositing corporate monies into personal rather than corporate accounts (or vice versa). 2. Payment of personal obligations with company funds. 3. Payment of company obligations with personal funds. 4. Failure to set up separate company bank accounts. 5. Depositing and withdrawing company monies in and from another business's bank account. 6. Failure to make payments to the company for it's services. 7. Failure of the company to pay for goods or services it receives from you or related companies. 8. Moving assets between companies or between a company and its owner(s) for the main purpose of generating or accessing cash. 9. Payments for company services or goods being made to the business owner individually, rather than to the company. 10. Failure to maintain separate bank accounts for each company division or subsidiary. 11. Failure to properly document loans made to or by any company divisions, subsidiaries, shareholders, officers or directors. 12. Failure to subordinate loans to or from shareholders, directors, officers or subsidiaries to loans from third parties. 13. Failure of loan documents to identify terms that demonstrate the loans were made in an arms-length fashion. 14. Failure of the parties to the loans to comply with the terms of the loan. 15. Failure to pay for use of assets that are shared by more than one company or any subsidiaries. 16. Failure of one related company to reimburse another for services or materials received. 17. Failure to fairly calculate reimbursement charges between companies which share assets, employees and related costs. 18. Failure to timely pay reimbursement charges or to charge interest. 19. Failure to properly account for costs shared between companies, and for those companies to pay their proportionate share of such costs from their own bank accounts. While researching the issue of commingling, we noticed a significant pattern in the cases: in virtually every case where the courts identified the factors leading to veil piercing, commingling of funds was mentioned first. This does not necessarily mean the courts weighed this factor more than others. However, it does imply that commingling is one of the most common errors practiced by business owners. Our advice: If you loan money to another entity or to a company director, officer or shareholder use Bulletproof Veil's Meeting Minder to do it properly (see Reference Library - Agenda Menu - Company Loans to Third Parties). Don't commingle company assets with personal assets. Don't commingle one company's assets with those of another in which you have ownership. Review your business practices to ensure you are not engaging in any of the conduct on the list. If you are doing some of these things, STOP. The strength of your company's corporate veil may depend on it. - Stanford A. Graham, ESQ Mr. Graham is an Attorney specializing in Business Litigation, Entity Structuring, Business Compliance & Contract Law. Material discussed is meant for general illustration and/or informational purposes only and it is not to be construed as tax or legal advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary.

There's been a number of queries, comments etc on this board about corporations, especially S Corps, being the preferred choice because 'everyone is doing it,' but even without abusive misuse of corporate funds, many of our clients, and we professionals, do not think this issue through. E.g., in most states, there must be two officers so who is usually named as the second officer, and who is allowed to sign checks? The spouse! Often our clients have no choice, but this simple action can begin the chipping away of corporate protection. Maybe a SMLLC could afford the same protection, though perhaps taxes might be higher.

Moral: there are no 'no-brainers' in entity selection.

McNamee v. Treasury, CA2, 99 AFTR 2d 2007-¶998, 5/23/07

Dear Client:

Your company, as of September 28, 2001, has been in existence for over three years. I would like to suggest a Corporate Profile Analysis for your corporation. This analysis would critique that the corporation was abiding by the federal and state laws regulating corporations under the U.S. Tax Code and Chapter 180 of the Wisconsin Statutes.

As a Corporate Profile Analyst I have been able to help Closely-Held Corporations by analyzing and detecting areas of inconsistency in the management of the corporate entity. It has been my experience that many Closely-Held Corporations do not always abide by the rules that are set up for a corporate entity. I assume you understand that a corporation is an entity unto its self. Therefore, this entity protects the officers and shareholders from fiduciary liability under certain circumstances.

As an example: During audits of Closely-Held Corporations the IRS checks the minutes of the Board of Directors meetings. They are looking for items listed on the corporate tax return that were not authorized by the Board of Directors.

Another question is: Does the Corporation function as a Corporation in its present corporate structure? The point being, that in any liability situation against the Corporation an attorney would request to see your Corporate Book containing By-laws, minutes of the Board of Directors meetings in order to establish whether the officers or shareholders would be covered under the corporate liability veil. Many times during litigation it has been found that a corporation was not operating as a corporation under the definition of the Internal Revenue Code. This causes the officers and shareholders to become personally liable for any damages awarded.

I am not indicating that the corporation is not being properly operated, I am concerned with the corporate entity.

If you decide to have a Corporate Profile Analysis done, I will require copies of the Wisconsin Certificate of Incorporation, Corporate by-laws, recent Wisconsin Corporate Annual Report, and all minuets of the Board of Directors meetings.

I would be happy to answer any questions you may have, please do not hesitate to contact me.

Sincerely, Douglas E. Bennett