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Piercing the Corporate Veil

Colloquial term what is often called Shareholder Liability, disregarding corporate [parent/subsidiary] separateness, parent liability, and refers broadly to the grounds under which a court can disregard the legal status and limited liability of a company and hold its owners responsible for its debts and liabilities. In US law, veil-piercing can generally occur under two different theories

The alter-ego test, when there is:

(1) no real separation between the shareholder and the corporation exists, which may be,

a. because the parent or shareholder completely dominates the company, i.e., same CEO, sole shareholding, etc., and/or

b. the wrongful conduct that led to the injury, or the debt incurred was principally or solely at the instruction or to the benefit of the parent/shareholder;

(2) an inequitable or fraudulent result will follow if the corporate veil is not pierced.

The somewhat similar instrumentality test, which may arise in circumstances of

(1) the control or complete domination of an entity by its corporate parent or shareholders

(2) for an improper purpose or use, e.g.,

a. to commit fraud or other wrongs,

b. to violate a legal duty

c. to commit dishonest or unjust acts;

(3) resulting damage or harm to the claiming party.

Realistically, in US cases, whether the veil can be pierced comes down to a ‘laundry list’ of factors. If the plaintiff can show enough are present, it may succeed

  • the parent and subsidiary have common stock ownership or a the defendant shareholder(s) have clear control;
  • a parent and subsidiary have common directors and/or officers;
  • the parent and subsidiary share common business departments;
  • the parent and subsidiary file consolidated financial statements and tax returns;
  • the parent finances the subsidiary or defendant shareholder finances the company;
  • the parent caused the incorporation of the subsidiary;
  • the subsidiary/company was thinly capitalized, i.e., operated with grossly inadequate capital;
  • the corporate parent pays the salaries and other expenses of the subsidiary;
  • the subsidiary is entirely dependant for business on the parent;
  • the parent/shareholder treats the subsidiary’s property as its own;
  • the day-to-day operations of parent and subsidiary are not kept separate;
  • Self-dealing by shareholders or the parent, i.e., the parent or shareholders causes the company to engage in contracts with them that are not beneficial or even harmful to the company’s interests and unduly in the interests of the parent or subsidiary; and
  • the subsidiary does not observe the basic corporate formalities such as keeping its own books and records and holding separate shareholder and board meetings.

In other jurisdictions, veil piercing may occur where the company was not genuinely a separate entity from its parents or where it was solely created to allow its parent or shareholders to work and benefit from a fraud, but avoid liability for it. A key consistent factor seems to be lack of separateness and failure to observe key formalities. The willingness of legal systems to pierce the corporate veil is highly variable.

Because technology startups are very likely to fail, risk that shareholders or parents might be held liable for its debts and dealings are more acute than usual. Lawyers for new companies therefore tend to stress the need to comply with corporate formalities and avoid self-dealing or other items set-forth in the ‘laundry list’ above.

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