Piercing the Corporate Veil

Many of us have heard the expression in the news “Corporations are People too.” What that means is that from the perspective of many laws, the act of a corporation is just like the act of an individual: it can only be attributed to the actor.  We attribute an individual’s action to that individual and we should only attribute the actions of a corporation to the corporation itself, not those who manage it or own its stock.

The reason that corporations are allowed to have their own independent legal personality is because the law is trying to encourage investment.  Typically corporations pool the investment funds of many individual investors, resulting in the accumulation of capital that no one individual could easily amass. It is this large sum of capital that can fund research and development of new technologies, building of new infrastructure, and testing and rolling out new business models.

The creators of the law regarding corporations determined that investors would be less likely to invest in new technologies and business models if they could be held personally liable for negative results that might stem from their investment.  By contrast, if it is the corporate form that makes such an investment, only the corporate form is liable for the results.

The result of this incentive scheme is that we now have millions of corporations, representing the pooled assets of many investors, that are functioning in our society and our economy as an independent legal entity. Other than certain exceptions, the shareholders and the employees and officers and directors of these companies, are not legally liable for the actions of these companies. This type of shield to protect employees, investors, officers, and directors is essential to enable those people to feel comfortable working for a corporation where they do not control its every move.

Sometimes those individuals controlling a corporation seek to use its status of personhood as a false shield against their own individual actions.  Essentially, they try to put the corporation as an intermediary in the path of bad behavior and hope that the corporation is the one to get in trouble, rather than themselves as an individual.

In order to counter such manipulation, many legal regimes have created a legal doctrine called Piercing the Corporate Veil.” Piercing the veil essentially enables the law and litigants to look through the corporate form to scrutinize those individuals pulling the strings of the corporation so those individuals can be held liable.

The two key criteria that most courts evaluate in order to determine whether to pierce the corporate veil is whether there has been: (i) an abuse of the corporate form; and (ii) fraudulent activity designed to enrich an individual controlling the corporate form.

In 2003 the US Supreme Court, in the case of Dole Food Company versus Patrickson, noted that there is typically a deference to the corporate form and piercing the corporate veil “is the rare exception,” which is typically only “applied in the case of fraud or certain other exceptional circumstances” and it is decided on a “case-by-case basis.”

So what does this mean for you as a creditor?

If you can pierce the corporate veil of an entity that owes you money, then there may be others behind that veil whom you can pursue for recompense.  However, in order for you to persuade a court to take this uncommon step, you need to show the court that the corporate form was abused in a manner that supported fraudulent behavior to enrich those behind the veil.

First you must establish that there has been abuse of the corporate form. One method for proving this is to examine whether the company observed the proper corporate formalities, such as not updating the company bylaws, failing to hold annual meetings and make appropriate corporate filings, not maintaining a stock ledger or proper accounting, or intermingling assets of the company with those of the of individuals who claim the protection of the veil.

Merely running the corporation poorly, such as failing to observe some of the formalities mentioned above, is insufficient to pierce the corporate veil. You also need to show that individuals behind the veil were abusing the corporate form for their own benefit.  In order to demonstrate this abuse,you may wish to document how an asset or right of the corporation was instead taken or enjoyed by an individual behind the veil for his or her own benefit.  For example,a corporation may rent a car for corporate business, but it is instead used largely for the personal benefit of one of the employees of the company and not for business.

The threat of piercing the corporate veil can be quite scary for officers, directors, stockholders, and employees of a debtor. Accordingly, if you have evidence of misconduct by any of these individuals, bring it to the attention of your bankruptcy advisor and it may be able to help your case as a creditor to enlarge the overall pie of monies available to all the creditors.  Proxifile and legal advisors Enumero Law are ready to help you explore this.

 

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