"Piercing the corporate veil" refers to a situation in which courts put aside limited liability and hold a corporation's shareholders or directors personally liable for the corporation’s actions or debts. Veil piercing is most common in close corporations.
While the law varies by state, generally courts have a strong presumption against piercing the corporate veil, and will only do so if there has been serious misconduct. Courts understand the benefits of limited liability, as it "encourages development of public markets for stocks and thus helps make possible the liquidity and diversification benefits that investors receive from those markets."
As such, courts typically require corporations to engage in fairly egregious actions in order to justify piercing the corporate veil. In general this misconduct may include abusing the corporation (e.g. intermingling of personal and corporate assets) or having undercapatitalization at the time of incorporation.
How States' Laws Differ
Laws regarding the piercing of the corporate veil vary from state to state, as demonstrated below.
- That the relevant corporation is only the alter ego or mere instrumentality of the parent corporation or its shareholder(s)
- That the alleged parent company or shareholder(s) also engaged in improper conduct
- Disjunctive test
- either excessive control or corporate misconduct must be shown for the court to pierce the veil
- Conjunctive test
- both excessive control and corporate misconduct must be shown for the court to pierce the veil
- The corporation must be influenced and governed by the person asserted to be its alter ego
- there must be such unity of interest and ownership that one is inseparable from the other
- the facts must be such that adherence to the fiction of separate entity would, under the circumstances, sanction a fraud or promote injustice
In New York, Walkovsky v. Carlton is a leading case on piercing the corporate veil. The court in that case held that a plaintiff needs to prove that a shareholder used the corporation as his agent to conduct business in an individual capacity. A court will pierce the corporate veil when it finds that the corporation is an agent of its shareholder, and will hold the principal vicariously liable, due to the respondeat superior doctrine.
In Texas, In re JNS Aviation, LLC (2007) is a leading case. The court found that the corporate veil could be pierced when any of the asserted veil-piercing strands are met. Further, courts will pierce the corporate veil when the member(s) intended to use the company to perpetrate an actual fraud, and the company did perpetrate an actual fraud "primarily for the direct personal benefit of the considered defendant."
To fulfill the strand component, the corporation must be 1 of 3 things:
- The alter ego of the parent corporation or its shareholder(s)
- The corporation is used to avoid legal limitations upon natural persons or corporations
- The corporation is a sham to perpetrate a fraud.
Further, the court stated that "actual fraud" occurs when all 4 of the following take place:
- "a party conceals or fails to disclose a material fact within the knowledge of that party"
- "the party knows that the other party is ignorant of the fact and does not have an equal opportunity to discover the truth"
- "the party intends the other party to take some action by concealing or failing to disclose the fact"
- "the other party suffers injury as a result of acting without knowledge of the undisclosed fact"