Piercing the Corporate Veil

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Defining the "Corporate Veil"

As we learned in our introduction to the corporation, the existence of a corporation as an entity that is separate and distinct from those who own and run it is a legal fiction. Despite the fact that a corporation may have a headquarters, a manufacturing plant, thousands of employees, and millions of dollars to its name, the reality is that the corporation as an entity – something that the law allows to take on any of these obligations in a legal sense – is a creation of fiction. In most cases, this fiction of the corporation has served the business community and investors well, providing them with an easy means of organizing their collective interests and protecting them from liability. However, under certain circumstances, the corporation may be used to injure and maim, costing individuals time and money and wrongly protecting those who are guilty.

In such a situation, where the corporation is being used to protect a wrongdoer from liability for his or her actions, the courts will reach behind the curtain – piercing the corporate veil – in order to hold accountable the individual or individuals who are abusing this legal privilege for their own ends. The result of an act by the court to pierce the corporate veil will be that the individuals running the company, and in many cases, the shareholders of the company as well, will be subject to the liability to those who have been wronged by the company. However, while in a typical corporation, it would be the corporation itself that would be liable for any damages, in the instance of a company that has been legally “pierced,” the corporation will be disregarded and its constituent members will be held personally liable. Or in other words, even though a corporation has been legally formed, courts will hold the officers, directors, and shareholders personally liable for corporate obligations.

EXAMPLE: Jake was the owner of Top Flight Furnishings, Inc., a small, closely held corporation. In truth, Jake used the company’s bank account as his own, used the company’s cars, and regularly took home furnishings from the store. After several accidents where chair legs bought at Top Flight were falling off, a group of customers sued the company. However, because Jake had been spending all the company’s money and had let its insurance policy lapse, the customers wanted to hold Jake personally liable. In court, Jake pleaded that because the company was a corporation and he was only a shareholder, he was protected from personal liability. However, the court, looking at the facts above, chose to “pierce the corporate veil” and hold Jake personally liable for the tort damages.

See Western Rock Co. v. David, 432 S.W. 2d 555 (Tex. Ct of Civ. App. 1968).

When will Courts Pierce the Corporate Veil?

There are a variety of circumstances when the court will consider piercing the corporate veil. However, while the nuances vary, the underlying theme is the same. When the corporation is being used as a liability shield for the actions of its managers, the courts, if asked, will often be willing to set aside the corporation and hold the managers liable for their acts.

When corporate formalities are ignored (“alter ego”)
In an alter ego fact pattern, the corporation is ostensibly serving as a second face for an individual or small group of individuals. This means that rather than doing business in their own names or as a partnership or sole proprietorship, the individual(s) involved have incorporated solely for the benefit of the liability protections of the corporate form. Subsequently, their acts have either turned illegal or abusive, and the courts step in to determine if the corporation or the individuals themselves should be liable.

Typically, an alter-ego-based piercing will occur in a small, closely held company, where the owners of the company have intermingled their personal and corporate assets, and often, their bank accounts. In such a situation, the court may find that the corporation is serving as the “alter ego” for that shareholder, but in essence, is not separate and apart from that owner, and the owner is, therefore, not entitled to liability protection. See Loving Saviour Church v. United States, 556 F. Supp. 688 (D.S.D. 1983).

The corporation is undercapitalized
If at incorporation the shareholders fail to provide adequate capitalization, they will be personally liable for the corporations’ obligations.

Hiding Fraud and Criminal Activity
Acts of fraud or crimes committed in the name of a corporation but for the benefit of its individual owners constitute a second scenario where courts are likely to disregard the corporate entity. Often, a situation will arise where individuals, intent on a criminal end, will incorporate their organization as a way of either masking their own identities or those of their criminal interests. In the end, however, if such a scheme is identified and brought to the court’s attention, it is frequently the case that the court will ignore the corporation and hold its owners and operators liable for the corporation’s crimes.

EXAMPLE: Guns 'R' Us has been selling machine guns, against state and federal law, to individuals with criminal records. The local district attorney chooses to prosecute the company. It quickly becomes apparent that while the bulk of the sales of Guns 'R' Us are legitimate, the company’s managers have been engaging in these illegal sales for their own financial profits. As such, the court has little hesitation in piercing the corporate veil and holding both the company and its owners criminally liable.

The Standards for Piercing the Corporate Veil and Why they Vary

One final note on piercing the corporate veil is that states often vary radically in the extent to which they are willing to go to protect the corporation as an entity. In several states, short of outright fraud and/or criminal conduct, the corporate existence will remain sacrosanct. See Consumer’s Co-op v. Olsen, 142 Wis. 2d 465 (Wis. Sup. Ct. 1988). In other states, the most trivial intermingling of funds may result in a court choosing to forego the corporate liability shield and hold all constituents of the corporation liable.

This sliding scale – sometimes harsh and sometimes forgiving – is based largely on the state’s view (and by that, we mean that state’s courts’ view) of the value of the corporation as a legal fiction. Some states espouse the idealistic viewpoint that the corporation is a legal entity deserving of protection comparable to that of an individual’s civil rights by virtue of the fact that not all members of a corporation are likely to be guilty of the harmful acts that led to the liability and that they should therefore be limited in their liability. Contradicting this is the similarly virtuous view of other states that see the corporation as no more than a means of organizing collective action. In this view, the corporation is no more than a sum of its parts and each of those parts need be held liable for any of its acts that contribute to the injury of others. While it is outside the scope of this course to detail the legal precedents that lead one state in one direction and another to a contrary position, it is worth keeping this division in mind when you encounter such problems in your legal employment.

Generally, it is the creditors, and sometimes, the shareholders, who are successful in piercing the corporate veil.

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