By David Bateman, CPA/ABV/CFF, CFE
Cases involving alter ego, successor liability and substantive consolidation are fact and circumstance intensive. While attorneys frequently use financial experts in cases involving damage calculations, a financial expert such as a Certified Public Accountant (CPA), and more specifically, one trained in forensic accounting, can be useful in providing testimony supporting or rebutting alter ego claims due to the nature of the factors to be considered in such cases. It is important for attorneys to understand the scope and nature of the opinions that such experts may be able to provide in support of their clients.
A concept that underlies the work of financial statement preparation by accountants is that of “substance over form.” This concept is defined in Generally Accepted Accounting Principles (GAAP) as follows:
“The quality of reliability and, in particular, of representational faithfulness leaves no room for accounting representations that subordinate substance to form.”
This is the same principle underlying the legal concept of alter ego as applied in successor liability or substantive consolidation cases. If the manner of recording of an accounting transaction lends itself to a misrepresentation to the reader of a financial statement, it is the responsibility of the accountant to determine the substance of the transaction and not to rely on its form alone. Such accounting analysis can be of assistance in determining whether accounting records support or refute claims of alter ego, successor liability or substantive consolidation.
While there is no consensus with the courts as to the key factors that are relevant in an analysis of alter ego, the following characteristics are among those commonly analyzed by financial experts to provide the trier of fact with the information necessary to make the legal determination.
Initial and Subsequent Undercapitalization. A financial expert can provide testimony as to the adequacy of the initial capitalization of an entity and can also provide analysis to determine whether assets have been transferred from an entity with significant liabilities to a related entity to shield those assets. Additionally, CPAs can provide analyses similar to those used in an audit to determine whether a company can exist as a going concern. A failure to meet the criteria for a going concern may be another indication of undercapitalization. Outside of the financial records, accountants are also experienced in reviewing legal contracts with financial institutions in determining whether a company is in compliance with debt covenants or other contractual requirements.
Confusion Regarding Corporate Identity. Accounting records and related financial documents may contain information that is useful in determining whether an entity is simply an alter ego of another entity. This may be indicated by discrepancies between the parties named on invoices as compared to the names recorded in the financial records, payments made to an entity deposited into a related entity’s bank accounts or even by a common accounting staff handling the books and records of multiple entities with no segregation of duties. While none of these factors alone is proof of alter ego, taken in total they may be persuasive in showing such a relationship.
Lack of Corporate Formality. CPAs regularly review minutes of meetings of the board of directors for entities they are auditing. The purpose of such a review is to determine if there are qualitative factors that should be considered in determining whether the financial statements are presented in accordance with GAAP. A financial expert may be able to provide testimony regarding the absence of such minutes (indicating that corporate formalities may not have been followed) or the content of the minutes if they provide clarification as to intercompany relationships that may not be reflected in the financial records. In addition, it is common to find in an alter ego situation that intercompany transfers of cash are made as necessary without any formal documentation such as a promissory note or related interest charges. This lack of documentation may be an indication that the relationship between the parties is not at arm’s length.
De Facto Merger. Related to the above factors is the doctrine of de facto merger. Under this situation, the underlying records may indicate that the effect of certain transactions were for the purpose of defrauding the creditors of an entity. This intent may be demonstrated through a financial analysis of the consideration paid for an asset transfer or the lack thereof. A CPA with the expertise to understand financial statements, underlying transactional data and supporting documentation can provide opinions as to whether it appears that there was an intent to hinder, delay or defraud creditors.
Litigators should consider the use of financial experts in alter ego, successor liability or substantive consolidation cases as their testimony may be used to bolster or refute both quantitative and qualitative issues in efforts to pierce the corporate veil.
 Statement of Financial Accounting Concepts No. 2.