Piercing the corporate veil
From LawGuru Wiki
The corporate law concept piercing (lifting) the corporate veil describes a legal decision where an officer, director, or shareholder of a corporation is held liable for the debts of the corporation despite the general principle that those persons are immune from suits in contract or tort that otherwise would only hold the corporation liable.
Corporations exist in part to shield their shareholders from personal liability for the debts of a corporation. Prior to the invention of the limited liability corporation in the 17th century, any partner in a general partnership could be held responsible for all the debts of the corporation. As the capital needed to finance projects grew, and along with it the necessity of borrowing money, investors were reluctant to invest because of the risk involved in essentially guaranteeing the entire debt of the business entity. In modern times, the only large business entity that can result in personal liability for huge sums of money is acting as a "name" for a large insurance underwriting concern, such as Lloyds of London (which, as it happens, also got its start in the 17th century by insuring ships). If, for example, any shareholder of General Motors were responsible for its debts, it is unlikely that any person would invest in the shares of the company. As such, shareholder liability serves a useful purpose in allowing huge sums of capital to be raised without risk to the individual investors.
Similarly, officers and directors of corporations, like other employees, are generally not held liable for the debts of the corporation. In a similar manner, no one would be willing to serve as an officer or director if they were liable for the corporation's debts.
However, as corporations in modern times moved from large organizations with hundreds or thousands of investors to business entities with only one shareholder, officer and director (often the same person), courts of law often found that individuals could escape liability for their own misconduct by holding assets in the name of the corporation. Unlike a large corporation where no individual shareholder could possibly obtain management authority over the corporation, closely held corporations are potentially expressions of the will of a few shareholders. Historically, corporations with 10 or more shareholders are not likely to be effected by piercing.
Although courts will generally not hold a shareholder, officer or director liable for actions that are legally the responsibility of the corporation, even if the corporation has a single shareholder, it will often do so if holding only the corporation liable would be singularly unfair to the plaintiff and the shareholder's actions were clearly designed to attempt to pass personal liability off to the corporation. However, the standard for doing so is very high. Generally, the plaintiff has to prove that the corporation was set up to perpetrate a fraud, or at least show that the incorporation was merely a formality and that the corporation never held proper shareholder meetings to distribute profits as dividends. 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 Court to Consider
- So grossly undercapitalized that fraud is likely?
- Failure to observe corporate formalities?
- Failure to pay dividends?
- Siphoning of corporate funds by the dominant shareholder(s)?
- Non-functioning corporate officers and/or directors?
- Absence of corporate records?
- Was the corporation being used as a “façade” for dominant shareholder(s) personal dealings?
- Other factors the court finds relevant
It is important to note that not all of these factors need to be met in order for the court to pierce the corporate veil. Further, some courts might find that one factor is so compelling in a particular case that it will find the shareholders personally liable. Generally, courts are hesitant to pierce the corporate veil, except in situations where outright fraud seems likely.
