A recent case in a North Dakota district court is a reminder to private equity funds and managers that, under certain conditions, they may be held responsible for actions of a fund’s portfolio companies.  Courts allow plaintiffs to pierce the corporate veil as a check against improper abuse of the corporate form.  When one corporate entity is under such extensive control by another that the first is merely an alter ego of the second, a court may permit a plaintiff to reach through the corporate structure to gain recovery.  This is particularly true if the first entity is undercapitalized.  Through this mechanism, limited liability does not mean immunity from liability, and under certain circumstances a plaintiff can hold the ultimate shareholders or owners liable for company obligations.

We recently posted about the risks associated with veil-piercing claims and the ways in which fund managers can protect themselves from exposure to these claims. Our first post on veil-piercing focused on Delaware standards, while this post discusses California law.

California law differs in several important respects from Delaware law on this topic. If a company is subject to suit in California, there are increased risks even if the company is incorporated elsewhere.  Courts may assert that California law should apply when the plaintiff is a California resident or when the company operates in California.

And where California law applies, courts may aggressively set aside corporate distinctions, leading to unanticipated results.

A veil piercing claim can be a worst-case scenario for a private fund manager dealing with a struggling portfolio company investment – the company fails, and ensuing legal claims are brought not only against the portfolio company, but also against the fund and its GPs. How can fund managers manage that risk?

Limited liability is a hallmark of the corporate structure. Yet the legal doctrines of veil piercing and alter ego permit courts to “pierce” or bypass the corporate structure in order to hold shareholders and directors personally liable for a corporation’s actions or debts.  These doctrines have important implications in the context of a fund that owns large stakes in portfolio companies.