Piercing the Corporate Veil: A Legal Mechanism for Accountability

Jun 27, 2024 | Law Student Blog,

By Matthew Cook, Saint Louis University School of Law, Juris Doctor Candidate, 2026

The concept of “piercing the corporate veil” is a crucial legal mechanism used to hold business owners personally liable for a corporation’s actions or debts. Normally, a corporation is treated as a separate legal entity, protecting them from personal liability. However, under certain circumstances, courts may decide to pierce the corporate veil and disregard this separation. This article explores the grounds upon which courts may decide to pierce the corporate veil, the legal principles supporting this topic, and the notable cases illustrating its application.

Legal Principles and Grounds for Piercing the Corporate Veil

Piercing the corporate veil is generally considered an equitable remedy used cautiously by courts to address fraud, misconduct, or injustice. The fundamental principle is to prevent individuals from abusing the corporate structure to avoid responsibility. The following grounds are commonly considered by courts when deciding to pierce the corporate veil:

Fraud or Misrepresentation: Courts are likely to pierce the veil if the corporation was used to commit a fraud. This includes situations where shareholders engage in dishonest practices, misrepresent the corporation’s financial status, or use the corporation to cover up fraudulent activities.

Under-capitalization: If a corporation is inadequately capitalized to cover its liabilities at the time of formation, that may indicate that the shareholders did not intend for the corporation to function independently. Undercapitalization means that a company does not have enough capital to conduct ordinary business operations. Courts may pierce the veil in cases where undercapitalization is used to deceive creditors.

Blending of Assets: The separation of corporate and personal assets is a hallmark of a legitimate corporation. When shareholders mix personal and corporate funds, pay personal expenses from corporate accounts, or fail to maintain separate financial records, it can be a sign that the corporation is a mere “alter ego” of its owners.

Failure to Follow Corporate Formalities: Corporations are required to adhere to certain formalities such as holding regular board meetings, maintaining minutes, and following their bylaws. Persistent failure to observe these formalities can indicate that the corporation is not functioning as a separate entity.

Injustice or Unfairness: Courts may pierce the veil to prevent an unjust outcome, such as when shareholders use the corporate entity to avoid existing obligations or legal responsibilities, leading to an inequitable result for creditors or other parties.

Notable Cases and Their Implications

Several landmark cases have shaped the doctrine of piercing the corporate veil, illustrating the various circumstances under which courts may decide to apply this remedy.

Walkovszky v. Carlton (1966): In this case, a pedestrian injured by a taxicab sought to hold the individual shareholders personally liable. The New York Court of Appeals held that merely undercapitalizing the corporation was insufficient to pierce the veil unless there was evidence of fraud, or the corporation was merely an instrumentality of the shareholders.

United States v. Bestfoods (1998): The U.S. Supreme Court held that a parent corporation could be held liable for the environmental violations of its subsidiary, meaning another division or branch of the company, if the parent exercised control over the subsidiary’s operations. This case highlighted the importance of operational control in veil-piercing decisions.

Anderson v. Abbott (1944): The U.S. Supreme Court ruled that shareholders could be held personally liable if they exercised complete domination and control over the corporation, using it to conduct their personal business, leading to an unjust outcome.

Challenges and Considerations

Piercing the corporate veil is inherently complex and fact-specific, making it unpredictable. Courts must balance the need to uphold the principle of limited liability, which encourages entrepreneurship and investment, against the need to prevent misuse of the corporate form or entity.

One of the primary challenges is establishing a clear and consistent standard for when the veil should be pierced. The factors considered can vary significantly by jurisdiction and case specifics, leading to uncertainty for businesses and their advisors.

Additionally, piercing the corporate veil often requires extensive evidence of misconduct or abuse, placing a heavy burden on plaintiffs. This evidentiary burden can be difficult to meet, especially when dealing with sophisticated corporate structures designed to create an ambiguous relationship between the corporation and its shareholders.

Application to Artists, Musicians, and Designers

Imagine a scenario where a musician signs a contract with a recording company to produce and distribute their latest album. The recording company promises significant marketing and distribution efforts. However, after the album’s release, the musician discovers that the company has been under-reporting sales figures and withholding royalties. Upon investigating, the musician finds that the company was severely under-capitalized from the start, with its sole purpose being to exploit the musician’s work without providing the agreed-upon support.

Further, the musician discloses that the company’s assets were mixed with those of its sole shareholder, who used company funds for personal expenses. The musician might seek to “pierce the corporate veil”, arguing that the company was a mere facade for fraudulent activities and personal gain. Therefore, they can attempt to hold the shareholder personally liable for the financial damages the musician suffered from.

Additionally, consider a scenario where a painter enters into an exclusive agreement with an art gallery to showcase and sell their work. They notice discrepancies in the sales reports and payments from the gallery, suspecting that the sales figures are significantly understated. The same elements apply here, and the painter can hold the owners personally liable, seeking compensation directly from the owner’s personal assets to cover their rightful earnings and damages.

Conclusion

Piercing the corporate veil remains a critical tool, although rarely applied, for courts to ensure justice and accountability in the corporate world. It serves as a check against the misuse of the corporate structure to commit fraud, evade liabilities, or conduct personal business under the appearance of corporate protection. While the doctrine is complex and its application varies, its existence reinforces the principle that the privilege of limited liability carries with it the responsibility of obedience to legal and ethical standards. Understanding the grounds and implications of veil-piercing is essential for both corporations and those seeking compensation against corporate manipulations.

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