In a Previous column, way back in December, I outlined sources of liability for outdoor recreation and adventure companies. Here, I will discuss preventing the loss of a business entity’s limited liability protections via “alter ego” claims, which can allow plaintiffs to go after the personal assets of business owners.
[dropcap]I[/dropcap]n 1998 an individual was injured in a fall while skiing at Sugar Mountain Resort. In the subsequent lawsuit, claims were not only levied against the resort, but also against the individual owner of the resort business and trusts that owned and leased the property on which the resort was located. The claimed damages in the lawsuit were above the policy limits of the resort’s insurance policy for such incidents, so the plaintiff, in attempting to find more funds to cover the remaining alleged damages, moved to make the owner of the resort company personally liable as well.
A business owner’s worst nightmare is being made personally liable for claims against the business entity. A big purpose and reason for business entity formation is that LLCs and corporations are designed to limit liability to the assets of the business itself, including those invested by the owners, but not those of the owners themselves. This valuable legal shield is known as the “corporate veil”, but when the courts allow veil of limited liability to be pierced, plaintiffs can potentially reach an owner’s personal assets.
The courts may allow a plaintiff to pierce the corporate veil if they can prove one of the following four legal theories with respect to the business: fraud, undercapitalization, deficient insurance, or alter ego. The last of these is the focus of this column and one of the more common theories of recovery argued in such litigation. To prove “alter ego” a plaintiff must establish that the business owner failed to separate his or her financial affairs from the entity’s financial affairs and/or observe statutory formalities regarding the division of authority within the entity, required meetings, accounting, and recordkeeping.
In the Sugar Mountain case, the court evaluated the management and finances of the business entity, along with what they described as principles of justice and public policy, to determine if the owner and/or trusts could be held liable for the plaintiff’s alleged damages. The court found that the individual owner, while not involved in day-to-day operations of the business, could potentially be personally liable in the ensuing lawsuit based upon the “alter ego” doctrine. The “alter ego” doctrine essentially states that when a business entity is being operated simply as a shell for the owner(s) and not truly being managed or properly used as an entity unto itself, then the owner(s) can be personally liable.
First, the court decided that the owner’s management of the business lacked proper and established procedure, in that it did not have regular board meetings and minutes, as outlined in a business’s bylaws or operating agreement. Additionally, there was only one owner/shareholder, who was also the president/director, which, in conjunction with lax business management, increased the reasoning for a successful “alter ego” argument. Further, through litigation discovery, it was unearthed that the individual owner would take payments out of the business entity as advancements on future dividends, before they were calculated and due, which the court determined to be misuse of the business entity and potentially amount to commingling of assets. This final factor was probably one of the most pivotal to the court’s decision, as financial fraud or blurred accounting between owner and business may generally be enough in and of themselves to allow a plaintiff to pierce the veil.
While the Sugar Mountain example includes an individual owner, who was somewhat intimately involved with the resort’s operations and finances, alter ego can just as easily be applied in a parent-subsidiary company structure situation. This issue was fleshed out in a Texas case involving a group of travelers staying at an international chain hotel in Mexico. The hotel chain was based out of the United States, but the Mexico hotel was owned and operated by a subsidiary company. The group had been directed to a small beach by the hotel concierge, and while on the beach a rogue wave caught the group in the water, resulting in the drowning deaths of two of them.
The plaintiffs in that matter alleged that the subsidiary company that owned and ran the Mexico hotel was simply a shell or “alter ego” for the parent company. The court opined that: “When there is such unity between the parent corporation and its subsidiary that the separateness of the two corporations has ceased and holding only the subsidiary corporation liable would result in injustice,” through a showing of blending or blurring of the lines between the two entities, is when piercing the corporate veil would be proper. However, even though the plaintiffs showed that the parent company owned a significant majority of the subsidiary’s stock, required the subsidiary to follow a number of established quality and procedure controls, and both companies shared common corporate officers, the court determined that this proved nothing more than a typical corporate, parent-subsidiary relationship. If the business is being run as a business and is properly insured and managed, then the purposes of the entities should remain in place.
Fortunately, in the Sugar Mountain matter, their counsels won a defense verdict after trial, as the plaintiff was unable to prove that the resort had done anything wrong or mismanaged its ski operations as outlined by industry standards and state statutes.[quote float=”center”]A big part of the resort’s success was based upon the testimony and work of the resort’s manager, who subsequently became involved in the ownership as well.[/quote]As a business owner, having employees, partners, or colleagues knowledgeable about the industry around which your business is centered, and the regulations and risks involved, can be extremely valuable in protecting your entity and, therein, yourself.
Forrest Merithew writes regularly about legal issues affecting outdoor recreation and gear businesses and activities.