Doctrine of Alter Ego – Meaning, Evolution and Usage

By | October 11, 2019
Place of Suits: Scope, Importance and Usage

The courts use the Doctrine of Alter Ego to get away with the corporate status of directors, officers or a group of stockholders in a corporation in connection to the liability that is limited to an extent. This is in order to make them personally liable for the actions done by them if they had done some action which is unjust or fraudulent in nature or if they had deliberately refused to do a particular thing that had deprived an innocent victim of redressal of an injury that is caused to them by virtue of such agents of the company.

It is considered by some scholars that corporation is the alter ego of its officers, directors or a group of stakeholders. This fact is considered true when the corporation is taken into use only for the transactions related to the personal business of the agents of the corporation and for all those transactions for which they are seeking immunity from the individual liability. If the parent company is in a capacity to regulate the conducts of the subsidiary company or if it directs or controls the activities pursuant to which it incurs limited liability for all of its wrongdoings.

The doctrine of alter ego can also be termed as instrumentality rule. This is so because the role of the corporation become equal to that of the instrument of its parent corporation for the personal advantage of its officers, directors or stakeholders. When the application of this doctrine is done by the court, it is said that the court had pierced the corporate veil.

The courts have refrained from applying this doctrine to the other forms of business such as limited partnerships and partnerships. The court did not step out to the apply the said doctrine on the corporations because the partners are not in the capacity to enjoy the same extent of limited liability as that is enjoyed by the officers, directors or stakeholders. However, on the basis of the comparison, it is dependent upon the directors of the limited liability companies to get the structure of their business formed in such a way that is just like to that of a corporation so that the managers and the members can be protected from the personal liability for the debts incurred by the companies of limited liability.

Several courts have also come to the conclusion of the application of the doctrine of alter ego to the LLCs. For instance, the Supreme Court of Wyoming held in the matter of Kaycee Land & Livestock v. Flahive[1] that the doctrine of piercing the veil is a remedy that is available to the act that is applicable on the limited liability companies of Wyoming.

SEPARATE ENTITIES AND LIMITED LIABILITIES

LLCs, as well as the corporations, have their own identity which is different from that of their owners. Pursuant to this separate identity, they have the capacity to enter into the contract, to sue and be sued, to conduct their business, to own their assets and so on. Supreme court has even gone to the extent of providing the corporations right to freedom of speech similar to that of the person by virtue of its judgments.

When some other entity files a suit against the LLC or the corporation in the court of law, the owners of the company do not have any sort of liability upon them and hence, they are always safeguarded from the personal liability. As per the legal terminology, they are under the shield of the law, which is known as the corporate veil.

The corporate veil is the only thing which stands in between these corporations and the controllers or owners of such corporations. Such protection is termed as limited liability. A business owner uses the corporate veil to protect his home and other commodities for the purpose of satisfying a lawsuit.

For instance, if one buys the shares from the listed stock of any company. Such a person becomes the partial owner of the company by virtue of those shares. If that company is found guilty in some ill doings, one cannot be held responsible for the acts of the company as he/she, being a shareholder, is safeguarded on the principle of limited liability.

THE CORPORATE FICTION DISREGARDED

LLC or corporation is an artificial entity and not a breathing or living entity. Henceforth, some scholars have criticised the theory of corporate fiction and said that the idea that the corporations have a separate legal entity from that of their owners or controllers is nothing but a fiction. Similar to this fiction, the topic of the corporate veil that exists between the entity and their owners is also a form of novel metaphor.

This fiction of corporate companies, sometimes under certain circumstances, may get disregarded in a court of law. When the court disregards the fiction, it implies that the court of law also does not agree with the acknowledgement of the existence of any kind of discernible difference between the owner and the entities. However, the acknowledgement that there exists no separation between the entity and its owners is not sufficient to make the owners liable automatically.

The courts are required to look for other evidence that proves the wrongdoings is a necessity for making the stakeholders, officers or directors personally liable.

The court has given the reasons in some of the cases for invoking the doctrine of the corporate veil. The reasons are as follows:

  • Alter ego
  • Inadequate capitalization
  • Fraud
  • When the finance and the business of both the owners as well as the companies start intermingling

In most of the case, inadequate capitalization is not enough for the justification of piercing of the corporate veil. But by virtue of the other reasons and especially on the ground of fraud, the veil has been pierced by the courts in most of the cases.

DETERMINATION OF CORPORATE VEIL

The court is required to look at various other factors in order to hold that the LLC or any corporation is an alter ego of its owner. The essential for ruling that an entity is alter ego of other entity if the parent company is the owner of its subsidiary as well as th4e operator.

There are some factors that form the basis of determining whether the charge of alter ego applies or not. These factors are as follows:

  • in the absence of any of the records owned by the company; and
  • when one fails to observe the formalities of the corporation; and
  • when the officers or the directors refuse to function; and
  • when there is gross under capitalization; and
  • when the company becomes nothing but a façade for the corporation or those shareholders that are dominating it; and
  • when the dividend is not paid; and
  • when the dominant shareholders or the corporate is siphoning the funds of the corporation; and
  • when the individual treats assets as if those assets are his own and not of the corporation; and
  • when the business and personal funds start intermingling.

INCEPTION AND EVOLUTION OF THE DOCTRINE OF ALTER EGO

The doctrine of alter ego is a very common principle of law that got further developed by virtue of judicial activism.

It was held in the matter of Tesco Supermarket Ltd v. Nattrass [1971] UKHL 1] that a corporation is an entity, which is different from that of its members. Such an entity is not acting with the help of its agents or servants but it is acting in the form of its alter ego in the form of the embodiment of the company and as if the mind of these agents is the mind of the company. If the mind of the agents is guilty, it would be construed as if the mind of the corporation is guilty.

On the other hand, there exists an uncertainty when it comes to the application of this doctrine. If the owners of the business entity and the entities are the alter egos of each other, then according to the doctrine of reverse piercing, the piercing will take place in the opposite direction and the corporations will be held liable for the debt incurred by the owner.

LIABILITY OF DIRECTORS UNDER THE DOCTRINE OF ALTER EGO

Directors, as well as all other persons who possess their control over the management of the affairs conducted by the company, can be made liable for the acts that are committed by the company or on behalf of the company as per the doctrine of alter ego.

The corporation works on the mind of its agents and does not have the mind of its own, the conduct of the corporation is according to the will and mind of the person who is directing it. On the other hand, it was held by the court that the doctrine of the alter ego has been applied in a reverse manner most of the times. Hence, the acts of the people, who are responsible for controlling the affairs of the company, is attributed to the company but vice- versa of this application is not permitted.

[1] 46 P.3d 323 (Wyo. 2002)


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Akriti Gupta
Author: Akriti Gupta

Akriti Gupta is a fourth-year learner of BBA LLB programme in Symbiosis Law School, NOIDA. She has done moots and has various publications in her name. Mooting and research papers have helped her a lot to enhance her researching and drafting abilities.

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