When getting into business – whether it is cannabis or otherwise – the first step is to set up a business entity. (This seems obvious but is still far from many in the cannabis industry.) One of the main purposes of creating a business entity is to limit exposure to the personal liability of the founders. Usually the business entity itself and not the investors, owners, or managers of the entity are liable for the company’s debts in almost all circumstances. One exception is the alter ego theory of responsibility.
The alter ego theory of responsibility attempts to access pockets outside the hypothetically responsible business entity. Doing so is known in Penetrate the company veil. The alter ego theory of responsibility is not limited to hacking a company into the pockets of its owners. It can also be used to access other entities. Hijab piercing can be done in several different ways.
- Vertical piercing refers to the piercing of the veil between a subsidiary and its mother to hold the parent company responsible.
- The horizontal hole refers to the use of the alter ego theory of responsibility to hold the sister company accountable.
- Reverse piercing refers to the use of the alter ego theory of responsibility to make the company responsible for the behavior of its owners.
The cannabis case recently filed in Oregon illustrates the uses of alter ego theory in its traditional and horizontal forms. Plaintiff is a well-known supplier of cannabis candies, licensed by the OLCC. The plaintiff markets the candy to licensed marijuana dispensaries across Oregon. Dispensaries sell candy to their customers. Since 2019, the plaintiff has done business with a group of dispensaries that operate under the same brand and have the same or substantially the same owners. (In other words, this brand operates several dispensaries across Oregon that have the same owners.) Each dispensary operates its own entity. But both are under the joint control of the same two people.
According to the complaint, the defendants failed to pay nearly $390,000 in cannabis candy. The candy was allegedly delivered by the plaintiff to various defendants, who accepted the candy without complaint and sold it to retail customers. After claiming the payment and not receiving it, the plaintiff sued more than 20 companies and their managers. In the absence of an alternate vanity theory of liability, each defendant is only liable for candy that he did not pay for. So the plaintiff’s recovery for each dispensary is limited.
But the plaintiff defended a traditional, horizontal claim to change self-responsibility. In other words, the plaintiff seeks to hold each defendant—all dispensaries and owners—responsible for the candy purchased by the other. A self-responsibility claim is not normally available to the injured party. There is also no claim for self-responsibility simply because the same individuals own multiple businesses. Likewise, a claim for self-responsibility is not available simply because all firms operate under the same brand or operate in the same industry.
So in what circumstances can a plaintiff make a claim to change self-responsibility?
Well, the details vary from country to country. But in general, for the horizontal altered ego theory, the plaintiff needs to claim that the defendants have joint supervision, control, management and unity of interest. For all theories, the plaintiff must usually allege that the defendants failed to follow the company’s procedures. This is a way of saying that the owners/companies did not act as if the corporations were separate or separate entities from themselves. This behavior may include failing to hold board meetings, mixing business and personal finances, or confusing corporate profits, expenses and losses. It may also include owners treating company accounts as mere “piggy banks” rather than properly issuing dividends or dividends. Other factors may include insufficient capital, insolvency at the time of the transaction in question, theft of funds by one or more owners, lack of company records, or non-operating employees or directors.
As the name suggests, the “alter ego” theory of responsibility ultimately relates to whether members or shareholders treat the corporate entity as “merely a means” or a “changing ego” to themselves. The barrier to penetration of the veil is usually high, and the court’s use of its equitable powers is exercised only when there is clear evidence that those who control a company have used the company for improper means such as fraud.
Keep in mind that the plaintiff must have a reasonable good faith belief that their claims are true. Often the claimant does not have enough information to claim responsibility for altering the ego theory. But when the plaintiff has such information, the claim for self-responsibility is strong. The plaintiff is allowed to exceed the normal limits of liability in the pockets of shareholders, members, sister or parent companies.