The concept of piercing the corporate veil remains widely misunderstood and frequently contested in courts. Generally, corporations are distinct legal entities, separate from their shareholders and are responsible for their own obligations. However, under certain circumstances, shareholders and corporate officers can be held personally liable for the debts or actions of the corporation.
Examples of piercing the corporate veil can be seen in early cases such as Berkey v. Third Ave. Ry. (1926), where Justice Cardoza stated:
“We say at times that the corporate entity will be ignored when the parent corporation operates a business through a subsidiary which is characterized as an ‘alias’ or ‘dummy.’” This judicially imposed exception allows courts to disregard the corporate structure and hold shareholders accountable for corporate acts.
- Think incorporation fully shields personal assets? Courts often say otherwise. This article explains when shareholders and officers can face personal liability.
- Grounded in cases like Berkey v. Third Ave. Ry. and Milwaukee Refrigerator Transit, it shows when courts disregard corporate separateness to address fraud or misuse.
- Watch for red flags that trigger risk: undercapitalization, ignored formalities, co-mingled funds and using the company as a stand-in.
- Why it matters to business owners: compliance can reduce exposure, avoid costly disputes and protect credibility before problems arise.
Formation and Purpose of a Corporation
Entrepreneurs create corporations and other business entities primarily to protect personal assets from business liabilities. However, simply forming a corporation does not guarantee this protection. Courts consider several factors when determining whether shareholders can be held personally liable:
- Legal liability is not automatic: Creating a corporation does not automatically shield shareholders from claims.
- State-by-state variation: Whether a creditor can pursue shareholders often depends on state law and principles of fairness.
- Intent and misuse: Courts examine whether the entity was formed to defraud creditors or conceal wrongdoing.
- Capital contribution principle: Shareholders are generally liable only for the capital contributed in exchange for their shares.
- Corporate separateness: The corporation exists independently from its shareholders, directors and officers, protecting personal assets when the entity operates legitimately.
In United States v. Milwaukee Refrigerator Transit Co., the court explained that corporate separateness may be ignored “when the notion of legal entity is used to defeat public convenience, justify wrongdoing, protect fraud or defend crime.”
Red Flags That May Lead to Piercing the Corporate Veil
While corporations are generally separated from their shareholders, courts may impose personal liability when certain warning signs appear. Common factors include:
- Undercapitalization
- Failure to follow corporate formalities
- Co-mingling of funds or records
- Misrepresentations
- Lack of substantive separation
- Use of the corporation as an instrumentality
Understanding Liability in Corporate Veil Cases
Courts evaluate corporate formalities when deciding whether to hold shareholders personally responsible. If formalities are not properly observed, liability protection can be waived and personal assets may be subject to claims. Family-owned businesses often fail to follow these requirements, usually due to financial limitations rather than intentional neglect.
The decision to pierce the corporate veil is fact-specific and considers the multiple factors outlined above.
For guidance on forming a corporate entity or other business structure, contact PLDO Managing Principal Gary R. Pannone at 401-824-5100 or gpannone@pldolaw.com.
References:
- Berkey v. Third Ave. Ry., 244 NY 84, 155 N.E. 28 (1926)
- Cornell Law Review, Volume 76, July 5, 1991, Piercing the Corporate Veil: An Empirical Study
- Model Business Corporations Act
- Cornell Law Review, Volume 76
- United States v. Milwaukee Refrigerator Transit Co., 142 F. 247, 255 (1905)
- Model Corporations Act
