Also known as: inadequately capitalized · inadequate capitalisation
Written by attorneys · grounded in primary & secondary sources — see below
A factor considered when determining whether to disregard the corporate form and impose personal liability on shareholders. It exists when a corporation's initial or ongoing capital is insufficient relative to the nature and magnitude of its business risks. Courts weigh it under a totality-of-the-circumstances test alongside other indicators such as failure to observe formalities and siphoning of funds.
Ira Irving formed Skyline Builders Inc. with only five thousand dollars in capital to bid on a large commercial project requiring heavy equipment. Ira ran the company alone, kept no records, and directed all payments into his personal account. When the firm could not pay its subcontractor and became insolvent, the court weighed the inadequate capitalization together with the other factors and pierced the veil to reach Ira personally.
India Inoue created separate corporations each owning one cab and capitalized them with minimal amounts. She siphoned all fares into her personal accounts, left the corporations without assets to meet judgments, and maintained no corporate records. A pedestrian injured by one cab obtained a judgment against the empty corporation and successfully sought to pierce the veil based on the inadequate capitalization combined with the other abuse factors.
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No. Courts apply a totality-of-the-circumstances test and treat inadequate capitalization as only one relevant factor. It must be considered together with other indicators such as failure to observe formalities, siphoning of funds, insolvency, and absence of records.
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Courts focus primarily on capitalization at the corporation's inception relative to the risks of the intended business. Later undercapitalization can also matter when combined with ongoing siphoning or other abuses that leave the entity unable to meet foreseeable obligations.
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Severe undercapitalization supports a finding that the corporation was merely a facade for the dominant shareholder's operations. When paired with commingling, nonfunctioning officers, or siphoning, it strengthens the case for disregarding the corporate form to prevent injustice to creditors.
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Generally no. While fraud is not always required, undercapitalization alone is insufficient. Courts require additional evidence that the corporation functioned as an alter ego or that respecting the form would sanction injustice.
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…; when they hold themselves out as being personally liable for the debts of the corporation ; or when they provide inadequate capitalization and actively participate in the conduct of corporate affairs”. (56 Cal. 2d, p. 579; italics supplied.) Examining the facts of the case in light of the legal principles just enumerated, he…