What does it mean to pierce a corporate veil and how can it be done? Here is a detailed explanation of what it means to pierce a corporate veil and how to do it.
What is a Corporate Veil?
Corporate veil is a term used to describe the separation of a corporation from its owners. As a separate entity, a corporation (including an S corporation) or Limited Liability Company (LLC) is set up to “protect” the owners of the corporation (or members of the LLC) from personal liability for the debts or negligence of the business.
Corporations and LLCs are legal entities, separate and distinct from the people who create and own them (these people are called corporate shareholders or LLC members). One of the major benefits of forming a corporation or an LLC is that, because the corporation or LLC is considered a separate entity (unlike partnerships and sole proprietorships), the owners and managers have limited personal liability for the company’s debts.
This means that the people who own and run the corporation or LLC cannot usually be held personally responsible for the debts of the business. But, in certain situations, courts can ignore the limited liability status of a corporation or LLC and hold its officers, directors, and shareholders or members personally liable for its debts. When this happens, it is called piercing the corporate veil.
What Does It Mean to Pierce a Corporate Veil and Why Is It Done?
Over the years, human ingenuity started using the veil of corporate personality nonchalantly as a cloak for fraud or improper conduct. Thus it became necessary for the Courts to break through or lift the corporate veil and look at the persons behind the company who are the real beneficiaries of the corporate fiction.
The phrase piercing the corporate veil is used to describe that action of a court that holds corporate shareholders and LLC owners personally liable for the debts and liabilities of a corporation. Piercing the corporate veil is important when certain issues arise where the individual has been harmed by the owner or manager of a company.
This then permits him or her to impose personal liability to the situation and ensure that the person’s own personal finances and assets are targeted by the litigation. Note that by piercing the corporate veil, it may be possible to litigate against the owner or manager of a business instead of the corporation itself.
This often usually only occurs when certain factors are in place to permit the victim to go through with this action. Through this type of lawsuit, the person harmed may target the personal finances, property and other assets of the owner of the company.
If a court pierces a company’s corporate veil, the owners, shareholders, or members of a corporation or LLC can be held personally liable for corporate debts. This means creditors can go after the owners’ home, bank account, investments, and other assets to satisfy the corporate debt.
But courts will impose personal liability only on those individuals who are responsible for the corporation or LLC’s wrongful or fraudulent actions; they won’t hold innocent parties liable for company debts. The rationale behind this is probably that the law will not allow the corporate form to be misused or abused.
In those circumstances in which the Court feels that the corporate form is being misused, it will rip through the corporate veil and expose its true character and nature
How a Corporate Veil Can Be Pierced in the United States
The ability of a business owner to use the protection of the “corporate veil” varies from state to state. There are states in the US that strictly uphold the concept of the corporate veil unless the business owner has plainly abused this protection.
Piercing the corporate veil is important when certain issues arise where the individual has been harmed by the owner or manager of a company. This then permits him or her to impose personal liability to the situation and ensure that the person’s own personal finances and assets are targeted by the litigation. Below is detailed guide on how a corporate veil can be pierced.
- Contact an Attorney
When the owner of a company has engaged in wrongful activity, he or she may be liable for damages. If this occurs, the victim of the incident first hires a lawyer. Based on the state laws, regulations of the local area, and Federal Trade Commission guidelines, it may be possible to attack the personal assets of the owner when he or she has committed a crime or harmed a person or entity directly or through his or her actions.
The intent to defraud an agency may not be enough without learning where the assets have been moved to, and if a product caused the incident, it must be shown in court that the owner knew this would occur without repairing the issue.
Even though there are various protections in place to keep the personal assets of business owner safe, specific elements could bypass these protocols. It is imperative that the victim contacts a lawyer to ensure these factors are available to attempt this type of Lawsuit. There are various methods that may be employed by knowledgeable lawyers to pierce the veil so that the corporate assets are bypassed and the owner is the target of litigation
- Get a Court Injunction and Conduct Further Investigation
If for instance the owner co – mingles their personal financial transactions with their company transactions, then the victim can argue that the company is not truly separate from the individual. If they can prevail in court with this argument, they have pierced the corporate veil and the owner is now personally liable for the money the business owes creditors.
The problem in piercing the corporate veil is that a victim may not really know to what extent the offence has occurred without getting to review all of the company’s financial transactions. The victim won’t usually know if there are grounds to pierce the corporate veil until they can get a court injunction to further investigate and it may even require a separate lawsuit.
- Schedule a Debtor Examination
After getting this injunction, a debtor examination can be scheduled where the victim can look for evidence of co-mingling or other offences. This can be easy if the debtor’s check register is available and the payees on checks are indicative of personal expenses.
However, it is rarely this simple. Individuals have to be personally served to appear at debtor exams. This can be difficult, requiring multiple postponements and sometime expensive stakeouts. They frequently miss the exams so they have to be rescheduled multiple times, each one requiring personal service to notify of the examination time. They do not always bring all the documentation, requiring more rescheduling and appearances.
If the check register does not clearly show co – mingling transactions or other financial offences, further investigation is required. All the company’s financial records need to be obtained. A professional needs to be hired to review the information and identify violating transactions.
- Go Back to Court and Prove the Case
If the victim is successful in getting evidence of co-mingling or other financial offences, they will have to get back in front of the judge. The case needs to be made that the financial offence is enough to pierce the veil and create personal liability. This means more court fees, hearings, and attorney time.
And even if the victim is successful, he or she still does not know if the business owner has personal assets available to pay off the judgment. If the business was their primary source of income, they may be under severe financial distress for many years and therefore the judgment will not get collected.
Many debt collection litigation attorneys will not want to take cases like this on a pure contingency basis unless there is strong evidence of eventual success. They know a lot of time and effort will be required and only a very small percentage of cases will result in piercing the veil and finding personal assets that can be seized to pay the judgment.
Despite all you may have heard about piercing the corporate veil, if you don’t have a personal guaranty in advance, you probably should not attempt to pierce the veil due to the cost and uncertainty. If you want the business owner’s personal assets as a secondary source of repayment, get a personal guaranty. Have it in mind that there is no guaranty of success in piercing the veil and/or ultimately collecting any money.
Thus, your time and investment can only be justified when very large amounts are owed, the individual has personal assets available to pay the debt, and you have strong anecdotal suspicion of significant financial offence. Since all of these conditions are rarely met, most people choose not to attempt it.