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 businessman has left his job as a director and has signed
a contract to not compete with the company he has just left for a period of time.
If he sets up a company which competed with his former company, technically it would be
the company and not the person competing.
But it is likely a court would say that the new company was just a "sham", a "fraud" or
some other phrase, and would still allow the old company to sue the man for breach of contract.
A court would look beyond the legal fiction to the reality of the situation.
Despite the terminology used which makes it appear as though a shareholder's limited liability
emanates from the view that a corporation is a separate legal entity, the reality is
that the entity status of corporations has almost nothing to do with shareholder limited
liability.
For example, English law conferred entity status on corporations long before shareholders
were afforded limited liability.
Similarly, the Revised Uniform Partnership Act confers entity status on partnerships,
but also provides that partners are individually liable for all partnership obligations.
Therefore, this shareholder limited liability emanates mainly from statute.
Basis for limited liability
Corporations exist in part to shield the personal assets of shareholders from personal liability
for the debts or actions of a corporation.
Unlike a general partnership or sole proprietorship in which the owner could be held responsible
for all the debts of the company, a corporation traditionally limited the personal liability
of the shareholders.
The limits of this protection have narrowed in recent years.
Shareholders are increasingly personally liable.
Piercing the corporate veil typically is most effective with smaller privately held business
entities in which the corporation has a small number of shareholders, limited assets, and
recognition of separateness of the corporation from its shareholders would promote fraud
or an inequitable result.
There is no record of a successful piercing of the corporate veil for a publicly traded
corporation because of the large number of shareholders and the extensive mandatory filings
entailed in qualifying for listing on an exchange.
Germany
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.
Today, shareholders can be held liable in the case of an interference destroying the
corporation.
The corporation is entitled to a minimum of equitable funds.
If these are taken away by the shareholder the corporation may claim compensation, even
in an insolvency proceeding.
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.
The veil is also often ignored in the process of interpreting a statute, 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.
There are also significant statements still among the judiciary in support of a broader
veil lifting approach in the interests of "justice".
The issue is discussed at length in a 2013 UK Supreme Court case, Prest v Petrodel Resources
Ltd.
Tort victims and employees Tort victims and employees, who did not contract
with a company or have very unequal bargaining power, have been held to be exempted from
the rules of limited liability in Chandler v Cape plc.
In this case, the claimant was an employee of Cape plc's wholly owned subsidiary, which
had gone insolvent.
He successfully brought a claim in tort against Cape plc for causing him an asbestos disease,
asbestosis.
Arden LJ in the Court of Appeal held that if the parent had interfered in the operations
of the subsidiary in any way, such as over trading issues, then it would be attached
with responsibility for health and safety issues.
Arden LJ emphasised that piercing the corporate veil was not necessary.
There would be direct liability in tort for the parent company if it had interfered in
the subsidiary's affairs.
The High Court before it had held that liability would exist if the parent exercised control,
all applying ordinary principles of tort law about liability of a third party for the actions
of a tortfeasor.
The restrictions on lifting the veil, found in contractual cases made no difference.
"Single economic unit" theory It is an axiomatic principle of English company
law that a company is an entity separate and distinct from its members, who are liable
only to the extent that they have contributed to the company's capital: Salomon v Salomon
[1897].
The effect of this rule is that the individual subsidiaries within a conglomerate will be
treated as separate entities and the parent cannot be made liable for the subsidiaries'
debts on insolvency.
Furthermore, it can create subsidiaries with inadequate capitalisation and secure loans
to the subsidiaries with fixed charges over their assets, despite the fact that this is
"not necessarily the most honest way of trading".
The rule also applies in Scotland.
Although the secondary literature refers to different means of "lifting" or "piercing"
the veil), judicial dicta supporting the view that the rule in Salomon is subject to exceptions
are thin on the ground.
Lord Denning MR outlined the theory of the "single economic unit" - wherein the court
examined the overall business operation as an economic unit, rather than strict legal
form - in DHN Food Distributors v Tower Hamlets.
However this has largely been repudiated and has been treated with caution in subsequent
judgments.
In Woolfson v Strathclyde BC, the House of Lords held that it was a decision to be confined
to its facts.
Likewise, in Bank of Tokyo v Karoon, Lord Goff, who had concurred in the result in DHN,
held that the legal conception of the corporate structure was entirely distinct from the economic
realities.
The "single economic unit" theory was likewise rejected by the CA in Adams v Cape Industries,
where Slade LJ held that cases where the rule in Salomon had been circumvented were merely
instances where they didn't know what to do.
The view expressed at first instance by HHJ Southwell QC in Creasey v Breachwood that
English law "definitely" recognised the principle that the corporate veil could be lifted was
described as a heresy by Hobhouse LJ in Ord v Bellhaven, and these doubts were shared
by Moritt V-C in Trustor v Smallbone: the corporate veil cannot be lifted merely because
justice requires it.
Despite the rejection of the "justice of the case" test, it is observed from judicial reasoning
in veil piercing cases that the courts employ "equitable discretion" guided by general principles
such as male fides to test whether the corporate structure has been used as a mere device.
Existing obligation The cases of Jones v Lipman, where a company
was used as a "façade" to defraud the creditors of the defendant and Gilford Motor Co Ltd
v Horne, where an injunction was granted against a trader setting up a business which was merely
as a vehicle allowing him to circumvent a covenant in restraint of trade are often said
to create a "fraud" exception to the separate corporate personality.
Similarly, in Gencor v Dalby, the tentative suggestion was made that the corporate veil
was being lifted where the company was the "alter ego" of the defendant.
In truth, as Lord Cooke has noted extrajudicially, it is because of the separate identity of
the company concerned and not despite it that equity intervened in all of these cases.
They are not instances of the corporate veil being pierced but instead involve the application
of other rules of law.
Reverse piercing There have been cases in which it is to the
advantage of the shareholder to have the corporate structure ignored.
Courts have been reluctant to agree to this.
The often cited case Macaura v Northern Assurance Co Ltd is an example of that.
Mr Macaura was the sole owner of a company he had set up to grow timber.
The trees were destroyed by fire but the insurer refused to pay since the policy was with Macaura
and he was not the owner of the trees.
The House of Lords upheld that refusal based on the separate legal personality of the company.
Criminal law 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.
In consequence those monies may become an element in the individual's 'benefit' obtained
from criminal conduct.
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 in which the court said:
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".
It is "hornbook" law that 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 carapace 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 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.
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, or if holding only
the corporation liable would be singularly unfair to the plaintiff.
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 "unity of interest and ownership", "wrongful
conduct" and "proximate cause".
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".
There is also the matter of what jurisdiction the corporation is incorporated in if the
corporation is authorized to do business in more than one state.
All corporations have one specific state to which they are incorporated as a "domestic"
corporation, and if they operate in other states, they would apply for authority to
do business in those other states as a "foreign" corporation.
In determining whether or not the corporate veil may be pierced, the courts are required
to use the laws of the corporation's home state.
This issue can be significant, for example, the rules for allowing a corporate veil to
be pierced are much more liberal in California than they are in Nevada, thus, the owner(s)
of a corporation operating in California would be subject to different potential for the
corporation's veil to be pierced if the corporation was to be sued, depending on whether the corporation
was a California domestic corporation or was a Nevada foreign corporation operating in
California.
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 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; Failure to pay dividends;
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;
Siphoning of corporate funds by the dominant shareholder(s);
Treatment by an individual of the assets of corporation as his/her own;
Was the corporation being used as a "façade" for dominant shareholder(s) 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.
Berkey v. Third Avenue Railway, 244 N.Y.
602, 155 N.E. 914.
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.
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
Undercapitalization Minton v. Cavaney, 56 Cal.
2d 576.
Mr. Minton's daughter drowned in the public swimming pool owned by Mr. Cavaney.
Then-Associate Justice Roger J. Traynor 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.
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.
Internal Revenue Service
In recent years, the Internal Revenue Service in the United States has made use of corporate
veil piercing arguments and logic as a means of recapturing income, estate, or gift tax
revenue, particularly from business entities created primarily for estate planning purposes.
A number of U.S. Tax Court cases involving Family Limited Partnerships, such as Strangi,
Hackl, Shepherd, and Bongard, show the IRS's use of veil-piercing arguments.
Since owners of U.S. business entities created for asset protection and estate purposes often
fail to maintain proper corporate compliance, the IRS has achieved multiple high-profile
court victories.
See also US corporate law
UK company law Notes
References Books
TL Hazen and JW Markham, Corporations and Other Business Enterprises ISBN 0-314-26476-0
pg. 124-144.
Articles AW Machen, 'Corporate Personality' 24 Harvard
Law Review 253 J Dewey, 'The Historic Background of Corporate
Legal Personality' 35 Yale Law Journal 655 C Alting, 'Piercing the corporate veil in
German and American law - Liability of individuals and entities: a comparative view' 2 Tulsa
Journal Comparative & International Law 187 AA Berle, 'The Theory of Enterprise Entity'
47(3) Columbia Law Review 343 EJ Cohn and C Simitis, Lifting the Veil' in
the Company Laws of the European Continent' 12(1) 'The International and Comparative Law
Quarterly 189 H Hansmann, R Kraakman and R Squire, 'Law
and the Rise of the Firm' 119 Harvard Law Review 1333
H Hansmann and R Kraakman, 'Toward unlimited shareholder liability for corporate torts'
100(7) Yale Law Journal 1879