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Piercing the Corporate Veil

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Piercing the corporate veil is when judges reject limited liabilities and hold directors or shareholders personally accountable for the company's acts or debts. Its employees and board of directors run a company, and it is made up of its members. Following its incorporation, the company is granted the status of a distinct legal entity, clearly defining its relationship to its members or shareholders. The term "corporate veil," also known as the "veil of incorporation," refers to this idea of differentiation.

Origin of Piercing the Corporate Veil

The century-old concept of a corporation's distinct legal personality—which gave rise to "the legal structure of modern business"—was established in Salomon v. A Salomon. To this day, the so-called corporate veil is uncontested. This unwavering rock promotes corporate growth and global trade by safeguarding the private assets of shareholders and offering a procedure for liability limitation that is permitted by company law. However, a strict application of the principle might occasionally harm the rights of parties dealing with the corporation because its controllers might be abusing the corporate structure by disguising their wrongdoing.

In Lee v. Lee's Air Farming Ltd., Lee combined a company over which he was the executive overseer. He identified himself as the organization's pilot and head within that restriction. He went missing in a plane accident while working on the organization's issue. Under the Workmen's Compensation Act, his widow requested compensation. If members of an organization try to take advantage of their status as a distinct legal entity, the court may occasionally reject the organization's status as such. The motivations of those hiding behind the mask are completely revealed. They are held accountable for using the organization as a platform for improper activities.

Subsequently, the doctrine of piercing the corporate veil was also recognized in various famous cases in the United States, such as:

  • Walkovszky v. Carlton is a well-known case in New York regarding corporate veil piercing. In that particular case, the court decided that the plaintiff had to demonstrate that a shareholder had used the corporation as his agent to carry out personal business. Because of the respondeat superior doctrine, a court will pierce the corporate veil and hold the principal vicariously liable when it determines that the corporation is acting as its shareholder's agent.
  • A landmark case in Texas is In re JNS Aviation, LLC (2007). The court determined that when any of the stated veil-piercing strands are satisfied, the corporate veil may be breached. In addition, the courts will breach the corporate veil in cases where a company perpetrates fraud "primarily for the direct personal benefit of the considered defendant," and the member(s) intended to use the company as a vehicle for the fraud.

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Piercing the Corporate Veil in the United States

Corporate veil piercing is the most hotly debated topic in corporate law in the US. Even though courts are reluctant to put a working shareholder at risk for actions that are rightfully the responsibility of the company, even in cases where the partnership has a single shareholder, they will frequently do so if the business is especially disobedient to corporate norms, to prevent deception, or to generate value in certain situations involving undercapitalization. In the US, they are supported by three fundamental pillars, which are as follows:

  • Unity of Interest and Ownership: In this scenario, the distinct personalities of the shareholder and the organization cease to exist.
  • Wrongful Conduct: If the company takes actions that are thought to be wrong.
  • Proximate Cause: If a company engages in unethical behavior, there should be anticipated consequences that could arise. Therefore, the party requesting the breach of the corporate veil must have experienced some sort of injury as a result of the company's unethical behavior.

For example , California law is becoming more liberal when it comes to piercing a corporate veil. There are many scenarios under which the veil can be pierced, and the courts may order that the veil be pierced even if an organization is just creeping on wrongdoing. On the other hand, Nevada's laws are very strict when it comes to veil piercing. The legal restrictions in Nevada make it possible to pierce the veil only in particular situations, which makes the process more difficult.

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Ways of Applying the Doctrine of Piercing the Corporate Veil

The company keeps its identity distinct and apart from its owners' or affiliated companies. To avoid personal liability, though, a corporate structure alone is not always sufficient. The courts have listed several circumstances that could result in piercing the corporate veil. The following is a list of a few notable ones:

  • Fraud: In Broward Marine, Inc. v. S/V Zeus, the U.S. District Court for the Southern District of Florida lifted the corporate veil, concluding that the principal shareholder of the company ought to bear personal responsibility for the company's fraudulent actions.
  • Failure to Maintain Separate Personality: In Ocala Breeders' Sales Co. v. Hialeah, the court lifted the corporate veil to investigate corporate officers' culpability. The court determined that a parent company had deceived the plaintiff when its subsidiary signed a contract requiring it to make specific capital improvements, even though the subsidiary was never capitalized and could not thus fulfill the contract.
  • Failure to Capitalize: It is never sufficient to breach the corporate veil alone to solve the problem of properly capitalizing a business. Nonetheless, courts will consider the company's assets to evaluate whether the amount of assets made available to creditors is reasonable. Businesses are not held to the same standard because the measure of assets is directly correlated with the business's purpose.
  • Breach of Corporate Formalities: Not adhering to corporate formalities could result in piercing the corporate veil. Once more, business owners who disregard corporate protocol do not always face consequences. Courts have held that when formalities are not followed, the shareholders' protection from legal liability is effectively waived, and the claimant can obtain the owners' assets. Smaller, family-run companies are likely to exhibit this since they are typically less careful about keeping up with corporate documentation.

Key Terms for Piercing the Corporate Veil

  • Liquid Assets: Assets that can be quickly converted into cash or made available in cash are known as liquid assets, and they may be needed to meet the minimum investment requirements.
  • Alter Ego: A legal theory known as "Alter Ego" holds that a company is not distinct from an individual or corporate shareholder.
  • Corporate Social Responsibility: CSR is a business strategy whereby organizations deliberately work to operate in ways that improve society and the environment rather than causing harm to them.
  • Capitalization: The process of giving money or capital to a business entity is known as capitalization, and it is frequently discussed in conversations about the minimal investment amount.

Final Thoughts on Piercing the Corporate Veil

One of the most contentious issues in corporate law is still piercing the corporate veil. Some categories that are considered the most unusual grounds for the Law Courts to breach the corporate veil are fraud, agency, sham or facade, unfairness, and group enterprises. However, these categories are by no means all-inclusive; rather, they are only suggestions.

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ContractsCounsel is not a law firm, and this post should not be considered and does not contain legal advice. To ensure the information and advice in this post are correct, sufficient, and appropriate for your situation, please consult a licensed attorney. Also, using or accessing ContractsCounsel's site does not create an attorney-client relationship between you and ContractsCounsel.

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