The law considers a corporation to be a legal “person”, separate and distinct from the owners in the case of a limited liability company (LLC) or its shareholders in the case of a corporation. A corporation or LLC alone is liable for its debts and other legal obligations. The owners and shareholders are protected from personal, individual liability for the debts and liabilities of the corporation or LLC.

For example, if a person brings a lawsuit against the corporation, the officers and shareholders cannot be brought into the lawsuit. They cannot be held liable for any legal obligation of the corporation.

“Piercing the corporate veil” refers to the act of a court in taking away the shareholders’ or owners’ immunity and holding them personally responsible for the debts and liabilities of the corporation. If a court pierces the corporate veil, it treats the corporation as if it is not a corporation and a creditor can go after its shareholders or owners to satisfy unpaid debts and other liabilities.

Piercing the corporate veil is most often done in situations that involve smaller, privately held business entities, such as close corporations or LLCs. Corporations of this type have a small number of shareholders and limited assets. A court might pierce the corporate veil if maintaining the separation of the corporation from its shareholders would promote a fraud or other unjust result.

A large, publicly traded corporation has never had its corporate status disregarded because there are such a large number of shareholders with no effective control over the operations of the corporation.

Also the extensive mandatory filings that are required for listing the stock on a stock exchange favor maintaining the corporate veil for shareholders. Large, publicly traded corporations are rarely run with the kind of informality that would lead to piercing the corporate veil. Most corporations. Most corporations have corporate counsel who can advise the corporation on a daily basis as to how to operate cleanly and limit its risk.

How Do Courts Determine If They Should Pierce the Corporate Veil?

Before piercing the corporate veil, a court will look at the following factors:

• Failure to maintain separation between the finances of the corporation and the owner: if the owners or shareholders finances are co-mingled, or not kept clearly separate, then a court is more likely to conclude that it is fair to pierce the corporate veil;
• Wrongful conduct: in a case of fraud, where it is clear that the corporation was a sham set up for the purpose of carrying on fraudulent activity a court will pierce the corporate veil;
• Inadequate Capitalization: a corporation must be capitalized when it is formed. This means it must have funds with which to operate, both at its start and on a continuing basis. In fact, corporations must be “adequately” capitalized if the owners do not want its corporate veil to be pierced. Corporations are usually capitalized through an initial investment of money or other assets.

  • Other types of capitalization include liability insurance coverage, loans to the corporation, and other equity. A court may find that a corporation’s capitalization is inadequate if it is too small in relation to the nature of its business and the risks that go with the business. A court is more likely to pierce the corporate veil if the corporation appears to have been inadequately capitalized;
• Failure of the owners to observe corporate formalities: if owners and directors fail to observe corporate formalities such as holding regular meetings of the board of directors and documenting the meetings, keeping personal and corporate finances separate and maintaining separate financial records, a court is more likely to pierce the corporate veil. Owners and shareholders should not make use of corporate assets as if they own them personally; they should not use the business’s offices, equipment, money, contact lists or software for personal purposes. They should not pay personal bills from corporate bank accounts or use their personal laptop for business purposes.

Piercing the corporate veil is a matter of state law, so courts in different states will weigh these factors differently. Some state courts might give more weight to certain factors than do other state courts.

In Texas, a plaintiff who wants to pierce the corporate veil must prove an actual fraud committed primarily for the direct personal benefit of an LLC member or corporate shareholder. In a reported case in Texas, a real estate broker set up a new corporation and moved assets into it from an old business which had been sued, so the old business would not have the funds to pay any judgement. The court refused to pierce the corporate veil, ruling that there was not enough evidence of an actual fraud.

In many states, on this set of facts, a court would pierce the corporate veil in order to make the assets of the new business available to satisfy any judgment against the old one whose assets had been looted.

An experienced business lawyer in the state where a business is located should know how courts view the factors in their state.

Will I Have an Easier Time Convincing a Court to Take Away a Small Business’s LLC Status?

Courts are more likely to pierce the corporate veil of a small business because small businesses are more likely to be actual alter egos of their members, owners or shareholders and to show this in their operations. Often a small business either operates without following the legally required LLC corporate formalities or without adequate funding.

Again, corporate formalities are steps a company takes to ensure the LLC operates separately from its members and in a truly business-like manner. In general, a business must maintain a separate identity from its owners by holding regular meetings of the board and keeping business and personal finances separate and generally operating as if owners and the business are, in fact, separate entities.

If these formalities are not observed, a court is likely to view an LLC or S corporation as a sham corporation rather than one that is legitimate in its operations.

Is a Large Corporation Immune from Losing Its LLC Status?

Courts might pierce the corporate veil of a large corporation when owners or directors create subsidiary corporations that are essentially sham corporations created to serve the parent. The subsidiary corporations are often used to transfer debts from the large corporation to the subsidiary in order to shield the parent corporation’s assets from a debt it wishes to avoid.

Courts will sometimes pierce the corporate veil to hold the parent liable for the obligations of the subsidiary. The factors that are considered by a court that is asked to make a parent corporation liable for the obligations of the subsidiary are similar to those used where a person seeks to make owners or shareholders liable for the obligations of a corporation.

A court will look to see if the interests of the two entities, parent and subsidiary, are truly separate. Of course if they are not, then the court is more likely to pierce the veil of separation. If circumstances exist to prove that treating the two entities as separate would perpetrate an injustice, again a court is likely to pierce the veil of separation between the two entities.

Do I Need the Help of an Attorney to Declare an LLC a Sham?

Yes, piercing the veil of an LLC or corporation takes a lot of legal expertise and knowledge. The expertise of an experienced corporate lawyer would be necessary. In fact, the recognition that a legal conflict requires piercing of the corporate veil to obtain justice for a person wronged by corporate conduct would probably require the expertise of an experienced corporate lawyer.

If you have a significant legal issue with a corporate business, you definitely want an experienced corporate lawyer representing your interests.