What is a “Piercing the Corporate Veil” Action?

Can your company hold up?

In corporate litigation, one of the most common challenges presented to legal professionals and claimants alike is the process of piercing the corporate veil. This legal action is intended to hold the individuals behind corporate entities accountable for the corporation's liabilities and misconduct. Understanding how such an action is undertaken will help you to implement better asset protection for your business. This article provides an overview of the strategies involved in piercing the corporate veil, reviews the conditions under which this approach may be pursued, and explains the evidentiary standards required, and the steps needed to avoid having your LLC or Corporate pierced.

Common Strategies Used in Veil Piercing Cases

Under common law, there are approximately 19 theories that allow the piercing of the veil. One prevalent strategy employed by legal professionals in attempts to pierce the corporate veil involves demonstrating that the corporation was merely an "alter ego" of its owners, thereby blurring the lines between personal and business assets and activities. This argument hinges on the evidence that individual shareholders disregarded the separate legal entity of the corporation, thereby entangling their personal interests and assets with those of the company. For instance, when business owners fail to follow corporate formalities, such as holding regular meetings, maintaining minutes, or properly allocating funds between personal and business accounts, they risk exposing themselves and their personal assets to liability. Courts often look for such commingling of assets or failure to maintain the separateness of the corporation as a crucial factor in deciding whether to pierce the corporate veil.

(For example: Bob goes to the grocery store and uses his business debit card to pay. He also fills his gas tank, pays for his personal cellular plan, etc. He could have transferred the money to his personal account, but it’s easier to just use the business account. This is termed “commingling” of business and personal funds, and it’s the most common way for a court to determine that the business is just an alter-ego for Bob.)

Another critical legal strategy involves proving fraudulent or unjust conduct by the company’s owners or principals. Fraudulent or unethical behavior that causes harm to creditors or other third parties can sometimes justify piercing the corporate veil. This strategy requires a meticulous presentation of evidence indicating that the shareholders used the corporation to perpetrate fraud or illegal activities, exploiting the corporate structure for personal gain while evading legal obligations or debts. In presenting such cases, attorneys must carefully document the deceitful actions and the direct link between these actions and the aggrieved parties’ financial losses or damages. Successful veil piercing cases under this strategy send a strong message about the seriousness with which the legal system treats the abuse of the corporate form for personal benefits. The courts are vested in holding individuals accountable for their actions that are inappropriately taken under the guise of corporate protection.

Legal Grounds for Piercing the Corporate Veil

The legal concept of piercing the corporate veil refers to a judicial act of imposing liability on the individuals behind a corporation or legal entity, thereby bypassing the otherwise protective shield of the corporation or company. This action, not taken lightly by the courts, is reserved for instances where adherence to the separation between corporation and individual would promote injustice or an inequitable result. The grounds for piercing the corporate veil, while varying by jurisdiction, generally hinge on clear evidence of abuse of the corporate form. This abuse is generally treated like fraud, where the corporation is used as a tool to deceive creditors or avoid obligations, or where there has been a commingling of corporate and personal assets which blurs the lines between the two to the point of indistinguishability.

Another pivotal aspect courts consider is the element of undercapitalization at the time of formation, which could indicate that the corporation was never intended to be a standalone entity capable of meeting its financial obligations. Another key element is the failure to observe corporate formalities. This includes neglecting to hold regular meetings, maintain corporate records, or make clear distinctions between the corporation's transactions and those of its owners or associates.

(For example: Bob runs his company the way he wants. He doesn’t have a company records book, doesn’t hold regular meetings, and doesn’t keep minutes or use resolutions to document decisions that he or his fellow shareholders make. A court would reasonably determine that the “company” is not a real company but rather just an alter-ego for Bob and the other shareholders. In that case, Bob’s personal assets are not shielded by the “limited liability” aspect of his company.)

Adherence to corporate formalities, proper capitalization, and transparency in transactions are critical in safeguarding the separation afforded by the corporate veil. Legal strategies to prevent piercing the corporate veil include diligent maintenance of corporate records, careful financial management, and the avoidance of personal guarantees by shareholders. By understanding and navigating these legal grounds, corporations and their stakeholders can better prepare themselves against the potential repercussions of veil piercing, ensuring the integrity of the corporate structure remains intact.

Protective Measures to Prevent Piercing of the Corporate Veil

To mitigate the risk of piercing the corporate veil, businesses must diligently adhere to both legal and procedural formalities that distinguish the corporation as a separate legal entity from its owners. One critical measure is maintaining accurate and separate financial records for the corporation. This involves not only keeping independent bank accounts but also meticulously documenting all financial transactions to reflect the corporate entity's autonomy. Blurring the lines between personal and corporate finances is a common trigger for legal actions aimed at piercing the corporate veil, emphasizing the need for clear financial boundaries.

Furthermore, ensuring that all corporate actions are properly authorized and documented reinforces the entity's legitimacy. This includes conducting regular shareholder and board meetings, recording minutes, and approving significant corporate decisions through the appropriate formal processes. Adherence to these governance practices not only solidifies the entity’s operational integrity but also builds a substantial defense against any claims attempting to undermine the corporation’s separate legal status. Moreover, compliance with state incorporation laws, including filing necessary annual reports and paying requisite fees, is essential to preserve the corporation’s good standing and further protect against veil piercing.

These protective measures, while seemingly bureaucratic, serve a pivotal role in fortifying the separation between the corporation and its owners, thus safeguarding personal assets from corporate liabilities. By meticulously observing these practices, businesses not only reinforce their defense against piercing the corporate veil but also enhance their operational credibility and integrity in the marketplace.

(For instance: In some jurisdictions, the court is careful to examine your company records book, if one exists. When the judge or opposing counsel detects that the records have all been produced recently, the concept of “the ink’s still wet” will be applied and the value of the records book as evidence that the formalities have been followed will be undermined or indeed “found” to be evidence that they have not been followed.)

In summary, understanding the intricacies of corporate veil piercing is essential for business entities aiming to safeguard their assets and to avoid litigants who are seeking to challenge the asset protection of your corporate structure. By familiarizing oneself with protective measures, recognizing common strategies employed in veil-piercing cases, and comprehending the legal grounds required for such actions, stakeholders can better navigate the complexities of corporate law. We highly recommend you obtain competent counsel to fortify your legal procedures to avoid a successful piercing the corporate veil action.

Curry Andrews, Attorney at Law