Piercing the Corporate Veil, Part I

Limited liability for shareholders is the norm for businesses; it is now specifically included as a part of the model business corporation act (section 6.22). There are numerous policy reasons for this, but the most compelling is it encourages risk taking. If it was possible for a shareholder to be personally liable for all corporate debts, risk raking would diminish, hurting overall economic growth. Limited liability also helps to increase liquidity for shares, as people purchasing stock in a corporation know their maximum loss will be the amount of capital they expend for the purchase.

But this was not always the norm. In fact, in the early 1800s several states imposed complete liability on shareholders. These states revised their laws as they saw investment capital leave for states where limited liability was the norm. By the mid-1850s, limited liability was the national norm.

However, there are times when a court will -- and should -- ignore this legal protection and "pierce the corporate veil" of limited liability. While law school corporate courses teach that this doctrine is well-defined, the reality is this legal field is very messy. One of the earliest attempts to explain the veil piercing doctrine was written by Maurice Wormser, in a law review article titled, "Piercing the Veil of Corporate Entity" which was published in the Columbia Law Review in 1912. It outlined several then standard veil piercing situations.

1.) Preventing fraud. Several cases were cited where shareholders of a debtor transferred assets to a newly formed corporation, essentially bleeding off assets from the company to prevent it from paying all its debts. This fact pattern would also run afoul of fraudulent transfer law.

2.) Alter Ego occurs when a corporation is a "mere instrumentality" of the shareholders. For example, suppose an individual drained his physical assets into a corporation, but failed to inform debtors of this fact, while at the same time, using the assets in the new corporation to live the high life. In this situation, the corporation would be an "alter ego" of the shareholder, because the shareholder was using the corporation to further his own lifestyle and not the corporation. There is also a certain amount of fraud in this argument for piercing.

3.) Evading a statute. The law review article cited several cases where companies had formed new companies to evade a specific law.