Piercing the corporate veil is a fancy phrase that means that somebody or something is attempting to hold the shareholders of a corporation personally liable for the corporation’s debts. Veil piercing is not an easy task and requires many factors to be proven. The main inquiry is, “has the corporate form been misused?” If it is concluded that the corporate form is being misused, the court will disregard the corporate entity and hold the shareholders personally liable.
Each state has different factors that it considers in determining whether to pierce the corporate veil. It would be inefficient to list all the various laws from all fifty (50) states, however, I will discuss some common factors.
Undercapitalization is a commonly considered by most states. Undercapitalization means that the corporation was not equipped with a reasonable amount of capital for the nature of the business involved. What is reasonable? If there was a clear answer to that, there would not be a need for lawyers! Reasonableness depends on many factors including type of business, size of business, etc. If a corporation is undercapitalized, this weighs in favor of the court piercing the corporate veil.
Another commonly considered factor is the failure to observe corporate formalities. Like I stated in previous posts, failure to observe corporate formalities will tip the scales towards the court piercing the corporate veil. Corporate formalities need to be observed by all corporations (except a close corporation).
Last, most courts consider whether a corporation was used to promote fraud, injustice, or illegalities. Let me put it this way, if you use the corporation to engage in illegal activity (for example, defraud somebody out of money or other valuables) the court will most likely pierce the corporate veil.
It is important to note that these are just some of the commonly considered factors. Every state has a different set of factors, therefore, check your local laws. Also, no one factor is controlling. Therefore, veil piercing does not turn on the absence or presence of a single factor. Last, even though no one factor is controlling, the factors are not weighed evenly. Factors such as illegal use weigh more than whether or not corporate formalities were observed.
This post is intended only to give you a brief overview of some corporate issues and in no way constitutes legal advice or a legal opinion. Always consult a professional before attempting anything stated above.