One of the major advantages of incorporation is that it protects shareholders from personal liability. For that purpose, corporations can legally limit their liability exposure by creating corporate subsidiaries to conduct certain operations and take on debt. This way the subsidiary company protects the parent company from liability. Nevertheless, creditors can ask the court to disregard the corporate status of a subsidiary and “pierce the corporate veil” to hold the parent company liable beyond its capital contribution to the subsidiary.
Corporate veil can be pierced in a parent/subsidiary context and also when the corporation only has one individual shareholder and no subsidiaries. In the latter case, you would be personally liable for the liabilities of your corporation. According to a recent study, California courts pierce the corporate veil in 50.86 percent of cases. Peter B. Oh, Veil-Piercing, 89 Tex. L. Rev. 81, 115 (2010).
Reasons for piercing the veil
Usually plaintiffs try to pierce the corporate veil to get to the parent’s or your personal pockets when the corporation’s assets are insufficient or unreachable. The court may pierce the corporate veil either before or after rendering a judgment on the merits.
In some cases the plaintiff may ask to pierce the corporate veil for the strategic purpose of acquiring a more convenient jurisdiction and/or jurisdiction with more favorable laws. This is often the case when the parent company is outside of the US and is doing business through a US subsidiary. In that case, a plaintiff who makes it to the discovery stage is entitled to oblige the defendant to produce massive amounts of documents and witnesses for both the defendant’s parent company and its subsidiaries. Plaintiffs are entitled to that at the discovery stage because the US has some of the most generous discovery laws in the world. This, of course, significantly increases the value of the plaintiff’s case and makes the defendant more likely to settle.
The basic task in trying to pierce the corporate veil is to prove that the company, even though a separately incorporated entity on paper, is not really separate from its owner(s) or parent company.
Two basic theories available to plaintiffs are: alter ego theory and agency theory of veil piercing. Alter ego theory of piercing the corporate veil basically means that the parent or owner dominated the subsidiary with disregard of corporate formalities for the separate identity, and injustice to the plaintiff is likely to result unless the corporate veil is pierced. In order to prevail on the agency theory, a plaintiff must prove that the subsidiary was acting on behalf of the parent as its agent, while the parent exercised total control over the subsidiary. Ownership of subsidiary’s stock and overlap in management is usually insufficient to pierce the corporate veil on the agency theory.