Piercing the corporate veil[1]

Piercing the corporate veil or lifting the corporate veil is a legal decision to treat the rights or duties of a corporation as the rights or liabilities of its shareholders. Usually a corporation is treated as a separate legal person, which is solely responsible for the debts it incurs and the sole beneficiary of the credit it is owed. Common law countries usually uphold this principle of separate personhood, but in exceptional situations may "pierce" or "lift" the corporate veil.

 

A simple example would be where a businessman has left his job as a director and has signed a contract to not compete with the company he has just left for a period of time. If he sets up a company which competed with his former company, technically it would be the company and not the person competing. But it is likely a court would say that the new company was just a "sham", a "fraud" or some other phrase, and would still allow the old company to sue the man for breach of contract. A court would look beyond the legal fiction to the reality of the situation.

 

Basis for limited liability

Corporations exist in part to shield the personal assets of shareholders from personal liability for the debts or actions of a corporation. Unlike a general partnership or sole proprietorship in which the owner could be held responsible for all the debts of the company, a corporation traditionally limited the personal liability of the shareholders. The limits of this protection have narrowed in recent years. Shareholders are increasingly personally liable.

 

Piercing the corporate veil typically is most effective with smaller privately held business entities (close corporations) in which the corporation has a small number of shareholders, limited assets, and recognition of separateness of the corporation from its shareholders would promote fraud or an inequitable result.

 

There is no record of a successful piercing of the corporate veil for a publicly traded corporation because of the large number of shareholders and the extensive mandatory filings entailed in qualifying for listing on an exchange.

 

In the United States, corporate veil piercing is the most litigated issue in corporate law. Although courts are reluctant to hold an active shareholder liable for actions that are legally the responsibility of the corporation, even if the corporation has a single shareholder, they will often do so if the corporation was markedly noncompliant, or if holding only the corporation liable would be singularly unfair to the plaintiff. In most jurisdictions, no bright-line rule exists and the ruling is based on common law precedents. In the United States, different theories, most important "alter ego" or "instrumentality rule", attempted to create a piercing standard. Mostly, they rest upon three basic prongs—namely "unity of interest and ownership", "wrongful conduct" and "proximate cause". However, the theories failed to articulate a real-world approach which courts could directly apply to their cases. Thus, courts struggle with the proof of each prong and rather analyze all given factors. This is known as "totality of circumstances".

 

There is also the matter of what jurisdiction the corporation is incorporated in if the corporation is authorized to do business in more than one state. All corporations have one specific state (their "home" state) to which they are incorporated as a "domestic" corporation, and if they operate in other states, they would apply for authority to do business in those other states as a "foreign" corporation. In determining whether or not the corporate veil may be pierced, the courts are required to use the laws of the corporation's home state. This issue can be significant, for example, the rules for allowing a corporate veil to be pierced are much more liberal in California than they are in Nevada, thus, the owner(s) of a corporation operating in California would be subject to different potential for the corporation's veil to be pierced if the corporation was to be sued, depending on whether the corporation was a California domestic corporation or was a Nevada foreign corporation operating in California.

 

Generally, the plaintiff has to prove that the incorporation was merely a formality and that the corporation neglected corporate formalities and protocols, such as voting to approve major corporate actions in the context of a duly authorized corporate meeting. This is quite often the case when a corporation facing legal liability transfers its assets and business to another corporation with the same management and shareholders. It also happens with single person corporations that are managed in a haphazard manner. As such, the veil can be pierced in both civil cases and where regulatory proceedings are taken against a shell corporation.

Factors for courts to consider

·        Absence or inaccuracy of corporate records;

·        Concealment or misrepresentation of members;

·        Failure to maintain arm's length relationships with related entities;

·        Failure to observe corporate formalities in terms of behavior and documentation;

·        Failure to pay dividends;

·        Intermingling of assets of the corporation and of the shareholder;

·        Manipulation of assets or liabilities to concentrate the assets or liabilities;

·        Non-functioning corporate officers and/or directors;

·        Significant undercapitalization of the business entity (capitalization requirements vary based on industry, location, and specific company circumstances);

·        Siphoning of corporate funds by the dominant shareholder(s);

·        Treatment by an individual of the assets of corporation as his/her own;

·        Was the corporation being used as a "façade" for dominant shareholder(s) personal dealings; alter ego theory;



[1] Piercing the corporate veil. (2015, January 14). In Wikipedia, The Free Encyclopedia. Retrieved 23:14, January 25, 2015, from http://en.wikipedia.org/w/index.php?title=Piercing_the_corporate_veil&oldid=642479997