Piercing the Corporate Veil

Piercing the Corporate Veil

Corporate veil is pierced when corporate form is disregarded and the individual shareholders, partners, or members are personally liable for all or a portion of the debts of the entity.

a)     Roots in equity:

(1)   Person or corp engaging in unfair dealings

(2)   While it is lawful to form a corp to shield personal liability, there are certain situations where it is inequitable (e.g., commingling personal expenses w/ corp’s expenses)

Case #1: Bartle v. Home Owner’s Co. Op

Corporate veil should only be pierced when there is a finding that fraud, misrepresentation, or illegality was involved in the corp.’s activities. High standard.

Case #2: Woodruff Construction, LLC v. Clark (factors to use as default)

(1)   Factors (not exclusive) a court will consider when deciding whether to pierce the corporate veil (generally factors that apply to smaller corps): (generally applies to corps with small number of shareholders who screw up to make it equitable for court to pierce)

(a)   Gross Undercapitalization

(i) Business does not have sufficient funds to manage its affairs or pay a judgment rendered against it.

(b)   Commingled finances or using corporate funds to pay personal debts

(i) Finances not kept separate from individual finances or individual obligations are paid by corporation

(c)   No separate books

(i) Are there separate accounts for parent corp and its subsidiaries?

(d)   Using corp to perpetuate fraud or for other illegal purposes

(e)   Sham corporation lacking a business or corporate purpose

(f)    Corporate formalities have not been followed

Case #3: Radaszewski v. Telecom Corp.

(1)   There are instances where injured party can pierce – i.e., reach the assets of one or more shareholders of the corp whose conduct created liability.

Case #3: Tripartite test (applied to larger corps & its subsidiaries – also apply woodruff factors)

(a)    Control (not only of stock, or finances) but complete dominion of policy and business practice in respect to the transaction being attacked so that the corp entity had no separate mind, will, or existence of its own;

(b)   Such control was used to by the D to commit fraud or wrong, or to perpetuate the violation of statutory or legal duty, or dishonest and unjust act in contravention of P’s legal rights; AND

(c)   The aforesaid control/breach of duty proximately caused the injury or unjust loss complained of.

(i) If all elements of test are met, corp veil may be pierced  

Reverse Piercing: Typical piercing claim

Typical piercing claim → P says disregard the corporate shield and go after shareholder/director personally

Reverse piercing claim

Reverse piercing claim → Shareholder/director wants the corporate shield to be disregarded

a)     Factors:

(1)   The degree of identity between the individual and their corp

(2)   The extent to which the corp is an alter ego of the owner

(3)   If others, such as creditors or other SH’s, would be harmed by the pierce.

b)     Court warns against reverse piercing – even more selective than regular piercing. Do not want debtors to be able to lower/raise the corp shield depending on which position best protects his prop.

Equitable Subordination 

1. Bankruptcy courts may subordinate claims by corporate insiders – that is, lower the normal priority of such claims – if the claim arose from a transaction that constituted a breach of FD [when shareholder/owner is also a creditor]

a)     Not as harsh as piercing – insider NOT held personally liable on corporate obligations, rather the insider’s claims are disregarded or subordinated to those of outside creditors when the insider has dealt w/ the corp unfairly or attempted to defraud creditors 

(1)   Doctrine protects those who innocently bestow credit to the corp > inside officer/creditor claims

(a)   Pepper v. Litton – was acting fraudulently, had no records of what he was claiming, wanted to assert claim but court puts outside creditors claim before his bc he was acting fraudulently.