Generally, the owners and managers of a company cannot be sued for the actions, debts, or liabilities of their company. For example, if company A breaches a contract, the other party to the contract can sue company A, but not the owners or managers of company A. The reason is because company A is viewed as a separate legal entity, capable of contracting and otherwise acting on its own.
One exception to this rule is known as the alter ego doctrine. Under the alter ego doctrine, courts will disregard the corporate form and hold individual owners and/or mangers personally liable for the conduct of the entity. In order to apply this doctrine, courts must find that the corporation lacks a separate identity from the individuals who operate it and that lack of separation results in injustice to the corporation’s debtors. The Utah Court of Appeals recently articulated Utah’s alter ego doctrine in the case of Simons v. Park City RV Resort, LLC, 2015 UT App 168, 354 P.3d 215.
Sorensen was the sole owner of a construction company known as NSC. Simons entered into a construction contract with NSC to build her home. Once construction of the home was completed, Simons noticed that several parts of the home were unfinished, not built in accordance with the specifications, or defective. Simons requested that NSC fix these issues, but NSC refused. Simons repaired these problems at her own cost and brought suit against NSC and Sorensen personally.
The district court ultimately dismissed Sorensen from the case, because the construction contract was only between Simons and NSC. Simons appealed this decision.
The appeals court began by emphasizing that, ordinarily, a corporation or limited liability company is regarded as a legal entity, separate and apart from its owners. Then, the court recognized that a party may pierce this corporate veil and obtain a judgment against the individual shareholders if the plaintiff proves that the corporation is acting as an alter ego of its owners. The court warned, however, it will grant relief under the alter ego doctrine reluctantly and cautiously. Simons was required to prove two elements in order to have the court apply the alter ego doctrine.
First, Simons was required to meet the formalities requirement. Specifically, Simons was required to show that there existed such unity of interest and ownership between NSC and Sorensen that the separate personalities of the corporation and the individual no longer existed. The court found that Simons did not meet this burden, because she did not provide any evidence of NSC's capital, profits, or liabilities. Instead, she only relied on the speculation that because NSC was solely owned by Sorensen, managed by Sorensen and his wife, and eventually ended up insolvent, it must have been undercapitalized, mismanaged, and non-distinct from Sorensen.
Second, Simons was required to meet the fairness requirement. Particularly, Simons was required to show that observance of the corporate form would sanction a fraud, promote injustice, or condone an inequitable result. Because the court found that the Simons did not meet the first element, the court did not analyze whether she could have met the fairness requirement.
The court concluded that the lower court properly excluded Sorensen from the lawsuit and allowed Simons to recover from NSC only.
Utah courts look to the following factors in analyzing an alter ego claim: (1) undercapitalization of a one-man corporation; (2) failure to observe corporate formalities; (3) nonpayment of dividends; (4) siphoning of corporate funds by the dominant stockholder; (5) nonfunctioning of other officers or directors; (6) absence of corporate records; (7) the use of the corporation as a facade for operations of the dominant stockholder or stockholders; and (8) the use of the corporate entity in promoting injustice or fraud.
If you own a closely held corporation, it is important to maintain the formalities of keeping your personal assets and records separate from the corporation’s assets and records. Doing so will ensure that you will be protected from the liabilities of the corporation.