5 Things Business Owners and Corporate Officers Need to know About Co-Mingling Business Funds and Personal Funds

Why Is It So Important To Keep Separate My Personal Assets and My Company?

Commingling personal and business assets and funds is a challenge for most small business owners who operate under a business entity such as coporation, incorporation, or LLC. It’s difficult to keep personal and business accounts completely separate, especially when cashflow is lacking or during the start-up phase.

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Some of the most common ways to commingle are:

Having only one bank account for personal and business needs.
Depositing business checks into your personal bank account.
Transferring money between business and personal accounts without documentation.
Withdrawing money from your business account to pay personal expenses without documentation.
Writing business checks for personal reasons/expenses, and vise versa.

The Doctrine was first established in California in 1921 in Minifie v. Rowley, 87 Cal. 481, 202 P. 673, and is intended to prevent individuals or other corporations from misusing the corporate laws by the device of a sham corporate entity formed or used for the purpose of committing fraud or other misdeeds. Under the Doctrine, when the corporate form is used to perpetuate a fraud, circumvent a statute, or accomplish some other wrongful or inequitable purpose, the courts may disregard the corporate entity and hold its individual shareholders liable for the actions of the corporation. “The separate personality of the corporation is a statutory privilege, and it must be used for a legitimate business purpose and must not be perverted. When it is abused it will be disregarded and the corporation looked at as a collection or association of individuals.” (In re: International Cab Company, No. Dist Court, Bank 98-30535 WDM).

Often, the co-mingling occurs because a business owner is trying to move money around to allow the business to run smoothly. They move personal funds across to pay a bill that might disrupt services if it is paid late or pay a personal debt off with a business credit card. However, co-mingling can have serious legal implications for you and your business.

Co-mingling is a Breach of Trust That Can Pierce the Corporate Veil

Anyone in a business who have access to the assets and accounts of a business have a fiduciary duty or duty of trust to the company. Co-mingling assets is considered a breach of trust by the law because it makes it difficult to separate which assets and funds are personal, and which belong to the business. The practice can open you up to civil liabilities as well as embezzlement or fraud charges.

Once a business owner practices co-mingling, the corporate veil may be pierced, meaning that action against your business could cause your personal assets, equity, and investments being used to satisfy damages. Comingling can destroy the point of incorporating as an LLC or corporation, which create separation between business assets and personal assets.

The main problem with co-mingling is that a judge and jury might struggle to see the lines between your personal life and business life. This will allow damages or creditors to pierce the corporate veil and pursue you personally for any debt or damages from your company.

Corporation Paying Personal Expenses

California Court of Appeal has rejected allegations that a corporation’s payment of the personal expenses of an officer establish alter ego liability if “the expenditures, for example, could have been made in lieu of salary or other compensation.” Aaron Air, LLC v. Universal Jet (Cal.App 2d Dist. Aug. 28, 2003) 2003 WL 22022002 (unpublished). Rather, the issue turns on the reasonableness. Courts reject alter ego liability where “[t]here [is] no evidence that the payments were excessive, as measured by market salaries, the number of hours worked or level of responsibility, or other criteria.” Wymore v. Minto (Cal. App. 1st Dist. Sept. 22, 2010) 2010 WL 3687511 (unpublished).

Piercing Corporate Veil Test and Elements

California courts developed a two-prong test for application of the Doctrine:

Unity of Interest. There must be such a unity of interest and ownership between the corporation and its equitable owner(s) that the separate personalities of the corporation and its shareholders do not truly exist.
Inequitable Result. There must be an inequitable result if the acts in question are treated as those of the corporation alone, or as more clearly in Robbins v. Blecher (1997) 52 Cal. App. 4th 886, the failure to disregard the corporate entity would sanction a fraud or promote injustice. See, Automotriz etc. De California v. Resnick (1957) 47 Cal. 2d 792, 796; Sonora Diamond Corp. v. Superior Court (2000) 83 Cal. App.4th 523, 539.

This is an equitable doctrine. Its purpose is to prevent injustice. As an equitable, fact-based remedy, the test is easy to state, but not easy to apply. Las Palmas Associates v Las Palmas Center Associates (1991, 2nd Dist.) 235 Cal App 3d 1220. The application of the Doctrine is done on a case-by-case basis, based on the facts. Most cases rely on the discretion of the trial court, and the appellate courts give them great deference. While the court must find both elements to apply the Doctrine, the reverse is not true. A finding of both elements does not require the application of the Doctrine. Associated Vendors, Inc., vs. Oakland Meat Company (1962) 210 Cal App. 2d 825. As an equitable remedy, there is no right to a jury trial. Dow Jones Co. v Avenel (1984, 1st Dist.) 151 Cal App 3d 144.

The First Prong: Unity of Interest

The Court in Arnold v Browne (1972) 27 Cal App 3d 386, 103 Cal Rptr 775 set forth a thorough list of factors tending to show a “unity of interest”:

Commingling of funds and assets.
Failure to segregate funds.
Diversion of funds or assets.
Treatment by shareholder of corporate assets as own.
Failure to maintain minutes.
Identical equitable ownership in two entities.
Officers and Directors of one entity same as controlled corporation.
Use of the same office or business location.
Employment of same employees.
Total absence of corporate assets.
Under-capitalization.
Use of Corporation as mere shell.
Instrumentality or conduit for single venture of another corporation.
Concealment or misrepresentation of the responsible ownership, management and financial interests.
Concealment or misrepresentation of personal business activities.
Disregard of legal formalities.
Failure to maintain arm’s length relationships among related equities.
The use of the corporate identity to procure labor, services or merchandise for another entity.
The Diversion of assets from a corporation by or to a stockholder or other person or entity to the detriment of creditors.
The manipulation of corporate assets and liabilities in entities so as to concentrate the assets in one and the liabilities in another.
The contracting with another with the intent to avoid performance by use of the corporation entity as a shield against personal liability.
The use of the corporation as subterfuge for illegal transactions.
The formation and use of a corporation to transfer to it the existing liability. In considering the factors on this list, appellate courts have held no one factor is conclusive. It is within the trial court’s discretion to consider the presence or absence of any of these factors or other relevant circumstances.

The Second Prong: Demonstrable Inequitable Result

The Doctrine is about “doing justice.” Mesler v Bragg Management Co. (1985) 39 Cal 3d 290, 216 Cal Rptr 443. To prevail, a plaintiff must prove that respecting the corporate form will lead to an inequitable result. The remedy is used to prevent fraud or injustice, allowing the court to put substance over form: the substance and nature of the injury over th corporate form. NEC Electronics, Inc. v Hurt (1989, 6th Dist) 208 Cal App 3d 772, 256 Cal Rptr 441

Note that a plaintiff does not have to prove all the elements of fraud. A showing of bad faith is enough. Talbot v. Fresno-Pacific Corp., 181 Cal. App. 2d 425, 431. However, without a showing of wrongdoing, injustice, or violation of statute, a court cannot use the Doctrine as a remedy. Sonora Diamond Corp., v. Superior Court (2000) 83 Cal. App. 4th 523. A showing that the plaintiff is merely an unsatisfied creditor of a business venture that ultimately did not work out is not enough. Sonora Diamond Corp. v. Superior Court (2000) 83 Cal.App.4th 523, cited in Green v. UNITED FOOTBALL LEAGUE LLC (2016) Court of Appeal, 1st Appellate Dist., 1st Div. 201 (Not for Publication).

Contact the experienced corporate attorneys at Nakase Wade to ensure you protect your personal assets from any business liability. We can assist with structuring your business, advise on the day-to-day operations, and keeping your personal and business assets and funds separate.

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