Accountants Can Help Identify Alter-Egos

Piercing the corporate veil is a law doctrine recognized throughout the country to prevent the abuse of corporations and protect creditors who might otherwise not be paid. When the veil is pierced, the courts will disregard the separate legal existence of corporations (including LLCs) and its shareholders or members. Corporations that appear separate but are not, are called alter-egos.


Advertisement


Thousands of executives with financial reporting responsibilities use the Comperio on-line library to access the type of information and interpretive guidance PricewaterhouseCoopers' own professional audit staff use around the world. Key content areas include guidance from the FASB, EITF, PCAOB, SEC, and others as well as PwC's interpretive guidance. Get more information and sign up for a complimentary 30-day trial.


To pierce the corporate veil, the plaintiff must prove that:

  1. There is a unity of interest between the corporation and the potential debtor, such that they have no practical separate existence, and
  2. an inequitable result will occur if the corporation alone is held responsible

Proving alter-ego liability is more complex, in California, for instance, the list of factors used to determine liability were laid out in Associated Vendors, Inc. v. Oakland Meat Packing Co. (1962) and demonstrate why accountants play a crucial role in identifying alter-egos. The possible factors identified in the Associated Vendors case include:

  • Commingling of funds and other assets, failure to segregate funds of the separate entities, and the unauthorized diversion of corporate funds or assets to other than corporate uses;

  • Treatment by an individual of the assets of the corporation as his own; diversion of assets from a corporation by or to a stockholder or other person or entity;

  • Disregard of legal formalities, including the failure to maintain minutes or adequate corporate/accounting records;

  • Domination and control of the corporation by its equitable owners;

  • Use of the same office or business location, the employment of the same employees and/or attorney;

  • Failure to adequately capitalize a corporation;

  • Use of a corporation as a mere shell, instrumentality or conduit for another person or entity; Use of the corporate entity to procure labor, services or merchandise for another person or entity;

  • Failure to maintain arm’s length relationships among related entities.

The factors listed above involve factual allegations which are subject to enormous potential dispute. Because of this, corporate veil cases are often expensive to litigate. However, accounting expert witnesses can lessen this burden because of their ability to summarize and interpret detailed records. Consequently, accounting experts can be a cost-effective way for both plaintiffs and defendents to present their positions.

Some examples of where accounting and valuation assistance can be invaluable:

    Determining whether assets were commingled requires an inspection of accounting and other business records that memorialize the transactions in question. Legal counsel will need to know how the transactions were characterized to ascertain whether monies and other assets were properly segregated.

  • Common business practices and shared services between related companies might (or might not) be undue domination by a parent or controlling shareholder. Accountants experienced with larger enterprises can provide insights as to whether the practices used in your situation are common, appropriate, and benefit the potentially-dominated corporation. This often involves measurement of the costs involved, and determination of the economic alternatives available to the potentially-dominated corporation.

  • Adequacy of capital is a judgmental determination that necessarily considers the risks of the business, and how these business activities were financed. In making these determinations, a financial analyst must consider the business model of the company being studied, and make comparisons to what other well-managed enterprises have been, and are doing.

  • The existence of common vendors, employees, and processes can be determined through an inspection of the accounting records of the parent, subsidiary, and other related firms.

  • Transactions between related parties may be appropriate (or not), depending upon the price and terms used for the transactions. This issue can be determined by an appraisal of the fair market value of the exchange.

  • Whether the potentially-dominated corporation is too dependent on its shareholder(s), or vice versa, can be determined by analyzing the operations of each. These transactions and operations are recorded in business records which an accountant will be able to understand and interpret.

  • The nature and timing of shareholder withdrawals and/or loans must be determined. Creditors appropriately want to know where the money went and when. Accountants can determine this through an inspection of the accounting records, checks, and deposits of sending and receiving entities.

The accounting records in any of these cases may be incomplete, or not trustworthy and a forensic accountant may be needed to assess the completeness and accuracy of the records obtained during discovery.

You may like these other stories...

Treasury prepares options to address tax inversionsDamian Paletta of the Wall Street Journal reported on Monday that US Treasury Department officials are assembling a list of administrative options for Treasury Secretary...
Deloitte CEO Joe Echevarria to retire to pursue public serviceMichael Rapoport of the Wall Street Journal reported that Deloitte LLP CEO Joe Echevarria plans to retire later this month to pursue his interest in public...
If your clients include retailers, pending federal legislation allowing states to tax Internet sales could mean big changes in the way they process and account for their sales and use taxes.In July, the Marketplace and...

Already a member? log in here.

Upcoming CPE Webinars

Aug 21
Meet budgets and client expectations using project management skills geared toward the unique challenges faced by CPAs. Kristen Rampe will share how knowing the keys to structuring and executing a successful project can make the difference between success and repeated failures.
Aug 26
This webcast will include discussions of recently issued, commonly-applicable Accounting Standards Updates for non-public, non-governmental entities.
Aug 28
Excel spreadsheets are often akin to the American Wild West, where users can input anything they want into any worksheet cell. Excel's Data Validation feature allows you to restrict user inputs to selected choices, but there are many nuances to the feature that often trip users up.
Sep 9
In this session we'll discuss the types of technologies and their uses in a small accounting firm office.