Piercing the Corporate Veil in EEUU

The so-called “corporate veil” is an immediate consequence of the limited liability principle, protecting shareholders’ personal assets against a company’s obligations.  Vesting corporations with an independent legal personality from their owners’ one strongly fostered private investment and entrepreneurship.

However, should the right to run a business under the form of a corporation be abused or perverted, New York courts may disregard the separate legal personality of the corporation and hold the owners personally liable for the company’s obligations by “piercing the corporate veil”. Indeed, “whenever anyone uses control of the corporation to further his own rather than the corporation’s business, he will be liable for the corporation’s acts” (Walkovszky v. Carlton, 1966).

The “piercing of the corporate veil” doctrine is intended to prove and hinder those instances in which a corporation becomes nothing more than a mere instrument of its owner or, in other words, when the corporation can be considered de facto an alter ego of an individual.

Whereas common, full ownership and control over a corporation may not be, however, a satisfactory criterion for New York courts to agree to pierce the corporate veil. In order to prove an owner’s personal liability for a corporation’s acts and debts, “some showing of a wrongful or unjust act toward a third party is required” (Morris v. State Department of Taxation & Finance, 1993).

Hence, the party asking the court to pierce the corporate veil should prove a “causal relationship” between corporate complete domination, i.e. the misuse of the corporate form, and the inequitable consequences of it (Giordano v. Thompson, 2005). To do so, several factors or indicia may lead a court to rule on the owner’s liability for corporate debts and conduct, such as:

• Assets commingling between the owner’s and the corporation’s net worth (e.g., transferring funds in and out of personal and corporate bank accounts; using corporate funds and assets for personal business or debts)
  
• Undercapitalization of a corporation
• Acting with negligence in corporate formal obligations (i.e., keeping corporate records updated, appointing directors, issuance of stock, etc.)
• The corporation and the owner’s personal office and phone numbers are the same.

Although none of the aforementioned criteria per se may be decisive in determining whether a shareholder can be held personally liable, together they may be regarded as aggravating factors, enabling the judge to reach an unfavorable verdict.

What happens if the formalities are not complied with?

The observance of formal obligations and disclosure requirements is an essential prerequisite for a corporation to exist and to produce legally binding effects. Complying with these formalities ensures the entity is duly incorporated and authorized to engage in business activities, while its legal and ownership structure are transparent and recognizable by third parties.

For example, in relation to formal obligations, if the corporation fails to draft and deliver its certificate of incorporation to the Department of State (Sec. 402 of Business Corporation Law), the recognition of its separate legal personality and its capacity to enter contracts and undertake legal actions will be voidable.

Yes. The "abuse of legal personality" concept can be found under the "alter ego doctrine". That is, where “corporation has been so dominated by an individual and the corporation separate entity so ignored that it primarily transacts the dominator’s business instead of its own and can be called the other’s alter ego” (Rohmer Associates v. Rohmer, 2007)

Therefore, the "abuse" of legal personality is deemed to occur when an owner takes advantage of the legal fiction granting the corporation a distinct legal personality so as to avoid the consequences of acts - illicit, fraudulent, or inequitable toward third parties - personally carried out by its owners.

Yes. Over time, the “piercing of the corporate veil” doctrine has been developed by New York courts (Lowendahl v. Baltimore & Ohio. R.R. Co. et al., 1936) as a legal vehicle to ensure the use of a corporation’s legal personality is lawful and respectful of the best business practices standards.

Yes. The corporate shield or corporate veil is one of the essential principles of corporate law. The corporate shield’s purpose is to foster individuals’ private investment and entrepreneurship by granting owners (shareholders, directors, and officers) the reassurance that they may not be personally liable for the actions or obligations undertaken by the corporation. However, while the corporate shield is often a status quo, there are certain exceptions allowing an extension of liability to owners. The alter ego doctrine is one of them.

No. The corporate shield is intended to grant its owners (shareholders, directors, and officers) protection against debts or obligations arising from the common risks of a business venture, yet not to exempt them from fulfilling their personal obligations, nor to relieve them from their personal liability for any misconduct they may have incurred into.

Under New York law, controlling shareholders who use their limited liability company to pursue personal interests rather than those of the company are regulated and can be pursued through several legal mechanisms, such as:

• Corporation or shareholder derivative lawsuits: a corporation can sue a controlling shareholder when there is a valid cause of action. That is, if a corporation has suffered damage coming from the actions undertaken by the controlling shareholder. Instead, should a corporation refuse to act, an individual shareholder or a group of shareholders could decide to sue the controlling shareholders, directors, or officers on behalf of the corporation itself. While corporations can bring a direct suit against a shareholder, directors, or officers, the shareholders can only bring a derivative suit, on behalf of the corporation’s interest, after the latter has refused to do so.

These claims are usually made following any fiduciary duties breach toward the corporation or shareholders. Under New York Corporations Law Sections 715 & 717), controlling shareholders, directors, and officers are required to perform their duties in good faith and with that degree of care that an ordinarily prudent person in alike position would use under similar circumstances. These duties can be simplified under the following premise: “pursuing the corporation’s best interest”.

These lawsuits can seek compensatory damages or injunctions relief in order to prevent future wrongdoings. 

• Fraud Claims: when a controlling shareholder engages in misrepresentation or omission of facts – with knowledge of its falsity and intent to defraud – on which a third party could reasonably rely and, therefore, is damaged as a result.

The corporation and its shareholders – on their own behalf or on behalf of the corporation –could consider themselves damaged by fraudulent activities committed by a controlling shareholder to benefit itself at the expense of the company. Thus, controlling shareholders committing fraudulent actions or deceptive practices in the marketing, sale, and purchase of securities sector that may result in financial damages for investors – shareholders included – can be held liable for under laws, such as New York Securities Law. Therefore, Shareholders could take action against controlling shareholders and seek damages compensation or injunctions reliefs.

• Regulatory action: In addition, the controlling shareholder could also suffer civil penalties and criminal charges from Government Agencies such as The Securities Exchange Commission (SEC), Department of Justice (DOJ), or Federal Trade Commission (FTC). Government Agencies have the authority to investigate, take actions against, or prosecute controlling shareholders using corporations shield for personal gains.

Generally, negligent conduct in doing business and in the management of a corporation does not automatically entail a disregard of the corporate form, nor a personal liability involvement to be borne by controlling shareholders.

Normally, negligent conduct falls within the ordinary risk of doing business. However, a court may decide to lift the corporate shield in severe cases that display a blatant lack of negligence, a breach of fiduciary duties, or a gross and flagrant conduct, resulting in damages to creditors.

New York legal system does not have the notion of a “hidden” partner or de facto administrator, except in the matter of estates of deceased individuals.

Yes, as per the so-called “alter ego” doctrine, piercing of the corporate veil may even occur between affiliated or subsidiary corporations when the parent (or dominant) corporation uses a subsidiary to engage in wrongful conduct.

Conclusions about the doctrine of corporate veil in your legal system.

It is well known that corporations are created so that its owners, shareholders, members, directors or officers are not considered personally liable for the actions taken in their capacity. However, when a corporation is used only as an alter ego or to commit fraud against others, courts in New York will pierce the corporate veil and will hold the perpetrator of the act or omission liable for such act or omission. Therefore, owners, shareholders, members, directors and officers should act in their capacities with care and professionalism, making sure all the corporate formalities are followed and abide to, to avoid incurring in such situation.