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14 • 2012

Avoiding Alter Ego Liability with Proper Corporate Minutes

One of the primary reasons for forming a corporate entity is to insulate shareholders from being held personally liable for the debts of the corporation. In fact, “[t]he law permits the incorporation of a business for the very purpose of enabling its proprietors to escape personal liability.”  Walkovszky v. Carlton, 18 N.Y.2d 414, 417, 276 N.Y.S.2d 585, 587 (1966). But that protection can be lost, and the “corporate veil” pierced to impose liability on individual shareholders, if the corporation is deemed to be the shareholders’ “alter ego.” In applying the alter ego doctrine, courts will examine a number of factors, none of which is determinative, in and of itself, of whether the corporate veil should be pierced in a particular case. See Associated Vendors, Inc. v. Oakland Meat Co., 210 Cal. App.2d 825, 838-40, 26 Cal. Rptr. 806, 813-15 (1st Dist. 1962) (cataloguing many of the factors).

Among the factors supporting the imposition of alter ego liability on the corporation’s shareholders is “the failure to maintain minutes or adequate corporate records[.]” Id. at 838, 26 Cal. Rptr. at 814. Remarkably, 50 years after Associated Vendors was decided, corporate principals continue to make the mistake of not maintaining proper minutes, even though this is one of the easiest factors to satisfy, particularly with regard to more rigorous factors such as insuring that the corporation is “adequately capitalize[d].” Id. at 839, 26 Cal. Rptr. at 814. In fact, in the Associated Vendors case itself, the court refused to pierce the corporate veil although the corporation being examined was arguably undercapitalized, where, among other things, the corporation held “a number of meetings” and kept “separate minutes” of those meetings.  Id. at 841, 26 Cal. Rptr. at 815.  Likewise, in Mix v. Tumanjan Development Corp., No. B157394, 2003 WL 21810813 (Cal. Ct. App. 2d Dist. Aug. 7, 2003) (unpublished), the corporation’s inadequate capitalization was not sufficient to establish alter ego liability as a matter of law where, among other things, the sole director, officer, and shareholder of the corporation conducted annual board meetings and “memorialized the meetings in the corporate minutes.” Id. at *7. Despite being the sole director, the individual even went so far as to call special sessions of the board to authorize important corporate decisions, such as the purchase of an office building, and those sessions “were also memorialized in the corporate minutes.” Id.

Other shareholders have not been so farsighted in maintaining the proper corporate records. By contrast with the individual in the Mix case, the corporate principals in Krausz Puente LLC v. Westall, No. B164989, 2005 WL 236862 (Cal. Ct. App. 2d Dist. Jan. 25, 2005) (unpublished), “elected not to memorialize [even] the most significant events in the history of the” corporation in the minutes, which did not reflect any discussion of the company’s lease with the plaintiff lessor, the build-out of the leased premises, or the eventual decision to wind down and go out of business.  Id. at *8.  Not surprisingly, the court of appeals affirmed the trial court’s decision to pierce the corporate veil and hold the principals personally liable for a judgment in excess of $4.5 million. It simply is not enough to have a minute book if no minutes are kept in that book.   See Jacques,  Inc. v. State Bd. of Equalization of Cal., 155 Cal. App. 2d 448, 459-60, 318 P.2d 6, 14 (Ct. App. 3d Dist. 1957).

Importantly, a plaintiff seeking to pierce the corporate veil has the burden of establishing the alter ego relationship. See, e.g., Auer v. Frank, 227 Cal. App. 2d 396, 410, 38 Cal. Rptr. 684, 693 (Ct. App. 1st Dist. 1964); Maggio v. Becca Constr. Co., 229 A.D.2d 426, 427, 644 N.Y.S.2d 802, 803 (2d Dep’t 1996). One of the first things the plaintiff will do in seeking to carry that burden is to request in discovery copies of the corporate minutes. See, e.g., Collagen Nutraceuticals, Inc. v. Nocell Corp., No. 09CV2188 DMS, 2010 WL 3069715, *3 (S.D. Cal. Aug. 4, 2010); Griffin Indus., Inc. v. Norfolk L.P., No. 08 Civ. 8489, 2009 WL 3097205, *1 (S.D.N.Y. Sept. 28, 2009).  Being able to respond with copies of properly maintained minutes, which should not be an arduous task, is a significant first step in protecting the shareholders from being held personally liable for the corporation’s obligations.  Cf. In re Oko, 395 B.R. 559, 564 (Bankr. E.D.N.Y. 2008) (shareholder held personally liable for $77,000 judgment where he could not produce a “single slip of paper” showing that he held formal meetings or kept corporate minutes).