Piercing the corporate veil

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Piercing the corporate veil or lifting the corporate veil is a legal decision to treat the rights or duties of a corporation as the rights or liabilities of its shareholders. Usually a corporation is treated as a separate legal person, which is solely responsible for the debts it incurs and the sole beneficiary of the credit it is owed. Common law countries usually uphold this principle of separate personhood, but in exceptional situations may "pierce" or "lift" the corporate veil.

A simple example would be where a businessperson has left their job as a director and has signed a contract to not compete with the company they have just left for a period of time. If they set up a company which competed with their former company, technically it would be the company and not the person competing.^[1] But it is likely a court would say that the new company was just a "sham" or a "cover" and that, as the new company is completely owned and controlled by one person, the former employee is deliberately choosing to compete, placing them in breach of that non-competing contract.

Despite the terminology used which makes it appear as though a shareholder's

Corporations exist in part to shield the personal assets of

German corporate law developed a number of theories in the early 1920s for lifting the corporate veil on the basis of "domination" by a parent company over a subsidiary. These cases have led to an encompassing codification of group law provisions in the AktG 1965 (§§ 291 - 319 AktG). By contrast, a general doctrine of piercing the veil for abuse of the legal personality of the company has never really taken hold in Germany. It was advocated in the fundamental work of Rolf Serick,^[3] but rejected by the prevailing "Normanwendungslehre".^[4] After a few early cases, the German judiciary did not go down the route of establishing shareholder liability via piercing the veil. In particular, it rejected piercing the veil on grounds of material undercapitalization several times.^[5] Today, the only remaining case of shareholder liability via piercing of the corporate veil is the inextricable commingling of the assets of the company and the shareholder ("Vermögensvermischung").^[6] But shareholders can be held liable in tort (§ 826 BGB) in the case of an interference destroying the corporation ("existenzvernichtender Eingriff").^[7] The corporation must not be stripped, without compensation, of funds that are required to meet its foreseeable future obligations. If these are taken away by the shareholder the corporation may claim compensation, even in an insolvency proceeding. The concept adds a solvency test element to the balance-sheet based rules of capital maintenance under §§ 30, 31 GmbHG and §§ 57, 62 AktG. ^[8][9]

This section needs expansion. You can help by adding to it. (July 2010)

United Kingdom

The corporate veil in UK company law is pierced very rarely. After a series of attempts by the Court of Appeal during the late 1960s and early 1970s to establish a theory of economic reality, and a doctrine of control for lifting the veil, the House of Lords reasserted an orthodox approach. According to a 1990 case at the Court of Appeal, Adams v Cape Industries plc, the only true "veil piercing" may take place when a company is set up for fraudulent purposes, or where it is established to avoid an existing obligation.^[10] However, cases were rare and their justification in light of the Salomon principle remained doubtful. In VTB Capital,^[11] Lord Neuberger sympathised with rejecting the doctrine altogether, but left the issue undecided because it did not matter for the outcome. Soon afterwards, in Prest v Petrodel,^[12] a divorce case where the matrimonial home was not held by the husband but by his company, the Supreme Court confirmed the existence of the doctrine in English law, but narrowed it down to practical irrelevance.^[13] The "fraud exception"^[14] was dismissed. According to the leading judgement by Lord Sumption, piercing the veil is a subsidiary remedy of last resort that only covers the avoidance of existing obligations ("evasion principle", as opposed to the cases of the "concealment principle" that does not give rise to a claim). On closer analysis, this was said obiter because the Court reached the desired outcome (attribution of the family home to the assets of the husband) by applying trust law. Nevertheless, Prest v Petrodel is generally assumed to state the current law in the UK, even though the restriction of "abuse" to evasion only can be questioned and there were statements in Prest v Petrodel that supported a broader approach.^[15] It is noteworthy that under English law, piercing the veil can never be used to make shareholders pay for contractual debts of the company because they have not been party to that contract.^[16] In the past, the veil was sometimes ignored in the process of interpreting a statute,^[17] and as a matter of tort law it is open as a matter of authority that a direct duty of care may be owed by the managers of a parent company to accident victims of a subsidiary.^[18]

Tort victims and employees

Tort victims and employees, who did not contract with a company or have very

In English criminal law there have been cases in which the courts have been prepared to pierce the veil of incorporation. For example, in confiscation proceedings under the Proceeds of Crime Act 2002 monies received by a company can, depending upon the particular facts of the case as found by the court, be regarded as having been 'obtained' by an individual (who is usually, but not always, a director of the company). In consequence those monies may become an element in the individual's 'benefit' obtained from criminal conduct (and hence subject to confiscation from him).^[37] The position regarding 'piercing the veil' in English criminal law was given in the Court of Appeal judgment in the case of R v Seager^[38] in which the court said (at para 76):

There was no major disagreement between counsel on the legal principles by reference to which a court is entitled to "pierce" or "rend" or "remove" the corporate veil. As a matter of law, a duly formed and registered company is a separate legal entity from those who are its shareholders and it has rights and liabilities that are separate from its shareholders. A court can pierce the limited liability of the corporate entity and look at what lies behind it only in certain circumstances. It cannot do so simply because it considers it might be just to do so. Each of these circumstances involves impropriety and dishonesty. The court will then be entitled to look for the legal substance, not the just the form. In the context of criminal cases the courts have identified at least three situations when the corporate veil can be pierced. First if an offender attempts to shelter behind a corporate façade, or veil to hide his crime and his benefits from it. Secondly, where an offender does acts in the name of a company which (with the necessary mens rea) constitute a criminal offence which leads to the offender's conviction, then "the veil of incorporation is not so much pierced as rudely torn away": per Lord Bingham in Jennings v CPS, paragraph 16. Thirdly, where the transaction or business structures constitute a "device", "cloak" or "sham", i.e. an attempt to disguise the true nature of the transaction or structure so as to deceive third parties or the courts.

United States

In the United States, corporate veil piercing is the most litigated issue in corporate law.^[39] Although courts are reluctant to hold an active shareholder liable for actions that are legally the responsibility of the corporation, even if the corporation has a single shareholder, they will often do so if the corporation was markedly noncompliant with corporate formalities, to prevent fraud, or to achieve equity in certain cases of undercapitalization.^[40][41]

In most jurisdictions, no bright-line rule exists and the ruling is based on common law precedents. In the United States, different theories, most important "alter ego" or "instrumentality rule", attempted to create a piercing standard. Mostly, they rest upon three basic prongs—namely:^[42]

• "unity of interest and ownership": the separate personalities of the shareholder and corporation cease to exist,
• "wrongful conduct": wrongful action taken by the corporation, and
• "proximate cause": as a reasonably foreseeable result of the wrongful action, harm was caused to the party that is seeking to pierce the corporate veil.

However, the theories failed to articulate a real-world approach which courts could directly apply to their cases. Thus, courts struggle with the proof of each prong and rather analyze all given factors. This is known as "totality of circumstances".^[43]

There is also the matter of what

Generally, the plaintiff has to prove that the incorporation was merely a formality and that the corporation neglected corporate formalities and protocols, such as voting to approve major corporate actions in the context of a duly authorized corporate meeting. This is quite often the case when a corporation facing legal liability transfers its assets and business to another corporation with the same management and shareholders. It also happens with single person corporations that are managed in a haphazard manner. As such, the veil can be pierced in both civil cases and where regulatory proceedings are taken against a shell corporation.

Factors for courts to consider

Factors that a court may consider when determining whether or not to pierce the corporate veil include the following:^[43]

• Absence or inaccuracy of corporate records;
• Concealment or misrepresentation of members;
• Failure to maintain arm's length relationships with related entities;
• Failure to observe corporate formalities in terms of behavior and documentation;
• Intermingling of
  assets
  of the corporation and of the shareholder;
• Manipulation of assets or liabilities to concentrate the assets or liabilities;
• Non-functioning corporate officers and/or directors;
• Significant undercapitalization of the business entity (capitalization requirements vary based on industry, location, and specific company circumstances);
• Siphoning of corporate funds by the dominant shareholder(s);
• Treatment by an individual of the assets of corporation as his/her own;
• Use of the corporation as a façade for personal dealings (alter ego theory)

It is important to note that not all of these factors need to be met in order for the court to pierce the corporate veil. Further, some courts might find that one factor is so compelling in a particular case that it will find the shareholders personally liable. For example, many large corporations do not pay dividends, without any suggestion of corporate impropriety, but particularly for a small or close corporation the failure to pay dividends may suggest financial impropriety.^[44]

Examples

• Benjamin Cardozo
  decided there was no right to pierce the veil for a personal injury victim.
• Perpetual Real Estate Services, Inc. v. Michaelson Properties, Inc. 974 F.2d 545 (4th Cir. 1992).^[45] The Fourth Circuit held that no piercing could take place merely to prevent "unfairness" or "injustice", where a corporation in a real estate building partnership could not pay its share of a lawsuit bill
• Fletcher v. Atex, Inc., 68 F.3d 1451 (2d Cir. 1995),^[46] finding insufficient that a parent company so dominated the operations of a subsidiary that the corporate veil should be disregarded.
• Minton v. Cavaney, 56 Cal.2d 576 (1961).^[47] Mr. Minton's daughter drowned in the public swimming pool owned by Mr. Cavaney. Then-Associate Justice Roger J. Traynor (later Chief Justice) of the Supreme Court of California held: "The equitable owners of a corporation, for example, are personally liable...when they provide inadequate capitalization and actively participate in the conduct of corporate affairs."
• Kinney Shoe Corp. v. Polan, 939 F.2d 209 (4th Cir. 1991).^[48]
  The veil was pierced where its enforcement would not have matched the purpose of limited liability. Here a corporation was undercapitalized and was only used to shield a shareholder's other company from debts.