Understanding Alter Ego Theory and Piercing the Corporate Veil

Alter ego theory provides protection against the limited liability clause, which states that investors cannot hold the owner financially responsible for a company's debts. The theory allows investors to claim the company owner's personal assets in the event of a huge loss and consequent bankruptcy.

Limited Liability

• The limited-liability clause is fundamental to alter ego theory. Limited liability means that you cannot claim personal assets of the owner if the business goes bankrupt. You can only lay claim to the business assets, not the owner's personal assets.

Asset Protection

• Suppose an owner registers a limited liability corporation (LLC) and makes a small investment--less than $1,000, say. Then the LLC incurs a loss and declares bankruptcy. The limited-liability clause protects the owner̵7;s personal assets. The other investors can only sell the business assets to reclaim their capital investment.

The Other Side

• But suppose the investors can prove that the owner was operating the LLC on a personal basis. Such proof means an end to the limited-liability clause.

Full Personal Liability

• The LLC's investors can file a petition claiming full personal liability. Such a court decision gives the investors the authority to claim the personal assets of owner.

A Matter of Justice

• Investors can claim the personal assets and get their investments' worth.