Incorporating your businesses is supposed to limit liability. The officers, directors and shareholders of a corporation are generally not personally liable when the corporation commits a civil wrong, loses a lawsuit or otherwise owes money. The corporation is its own legal entity and is fully responsible for its debts and losses.
Unfortunately, those who operate a corporation can sometimes lose this liability shield. This is referred to as “piercing the corporate veil.” While courts pierce the corporate veil cautiously and reluctantly, there are situations where it is necessary. Once the corporate veil has been pierced, individuals can be held personally responsible for corporate debts and losses.
The situations where a corporate veil may be pierced are limited, but they are very real. They often arise out of fraud or illegality by the corporation which the court is trying to redress. However, it is possible for the corporate veil to be pierced simply because the officers, directors and shareholders pay insufficient attention to the legal requirements of operating as a corporation.
For example, those operating a corporation may neglect to:
- Create and follow corporate bylaws and articles of incorporation
- Issue sufficient stock
- Have separate bank accounts for the corporation
- Hold regular and special board meetings
- Keep accurate minutes and other records
- Provide procedures for entering contracts
- Exercise all fiduciary duties on behalf of the corporation, such as avoiding conflicts of interest, putting the corporation’s interests ahead of personal interests, and avoiding insider trading and abuse of confidential information
Three other situations where the corporate veil could be pierced
It is unlikely that your corporate veil will be pierced for simple lack of following the formalities of operating a corporation. Instead, you would generally run this risk only when the court is attempting to remedy a wrong.
A court might pierce the corporate veil in order to bring a corporation into compliance with a particular statutory scheme, such as Social Security, or to accomplish a clear legislative goal. For example, a particular government benefit program might distinguish between owners and employees. If your corporation benefits from the program but your corporate form does not make the appropriate distinction, a court might remedy the problem by piercing the corporate veil.
Second, piercing the corporate veil is sometimes done to remedy fraudulent conduct by individuals within the organization. For example, if a shareholder or investor demonstrably led someone to believe that an obligation was a personal liability instead of merely a corporate liability, the court might impose personal liability on that shareholder or investor. In other words, courts will not allow the corporate veil to be used as a way to fraudulently avoid clear personal liabilities.
The third situation in which a corporate veil often becomes pierced is during bankruptcy. For example, if a board member foresaw the bankruptcy and used that knowledge to transfer assets to him- or herself or to favored creditors, the bankruptcy court might set aside this fraudulent conveyance and claw back the funds. The corporate form may be disregarded in an effort to eliminate opportunism by those operating the corporation.
If you are involved in commercial litigation or bankruptcy, it might be crucial for you to avoid piercing the corporate veil. Talk to your business attorney about your particular situation.