Piercing the Corporate Veil is the exception to the rule

March 6, 2017 - Posted by: admin - In category:

taxes - No Responses

Legal liability protection is one of the main reasons for corporate entities.  In most instances, these legal entities insulate owners from legal liability.

While there are often tax, accounting and other important reasons for corporations and LLCs in a business or investment setting, at the very top of any list of reasons to establish and properly maintain such a legal entity is the legal liability firewall concept fundamental to these corporate structures.  To simplify a potentially complicated subject, operating a business as a sole proprietorship or in the name of one or more partners tends to expose the owner(s) to a much higher risk of legal liability than when similar business operations are done through the vehicle of a corporation or an LLC.  This is partly because a corporation and and LLC offer a “corporate veil” of liability protection not present when one or more persons operate solely in their individual names.  In concept, this is rather simple to understand.  And while there are an innumerable number of variables when it comes to resolving potential legal risks and claims, the cardinal rule cited above is a reliable theme.

Customary incidents don’t make the news–that is the reality of the world in which we live. Rather, it is the unique occurrence that is, by definition, “news” and therefore we hear much on TV, radio and the internet about such unique occurrences.  Likewise, very often it is the unusual case which goes to trial and which then results in published legal opinions which are then read and described by academics and other industry “experts”.  And certainly among such unique and “newsworthy” categories of cases which tend to get a lot of publicity (at least in the legal world) are cases where courts have “pierced the corporate veil” and permitted liability for legal claims to flow outside of the distinct legal entity which was directly involved in a particular situation.  Such things can result in “big news” and be the subject to many a convention or seminar presentation.  Even so, these occurrences remain rare and exceptional.

Veil piercing is an equitable remedy which is utilized by judges only on very select occasions and is normally limited to scenarios where the legal entity’s ownership (whether persons or other legal entity) both: (A) dominated the legal entity in a manner that can be fairly described as the “alter-ego” of the legal entity; and (B) misused the legal entity to commit a fraud or crimes or otherwise achieve an injustice.  As part of this analysis, courts have looked to various related factors, including whether the legal entity was adequately capitalized, whether the legal entity failed to observe corporate formalities or to maintain proper records, whether the debtor entity was insolvent, whether the legal entity funds were improperly taken and used by the dominant owner (person or entity) and whether the legal entity was just a facade for the operations of the dominant owner.

Because the outcome of such unique cases can be quite extreme and noteworthy (i.e. deep-pocketed owners can be made to write checks with lots of digits), such cases get the notoriety and publicity mentioned above.  Even so, these are the rare occasion and the exception to the rule.  The rule is that the corporate veil is normally respected and preserved and owners are not often made to pay for the claims brought against the LLC or corporation in question.  Rather, the far more common outcome is that the assets of the target legal entity are available to satisfy creditors, including judgment creditors, while at the same time, the normal rule is that ownership which has operated the business in a manner that meets a fairly minimum level of legal formalities is protected from such legal claims brought against the company in question.

In summary, if you hear about an extreme circumstance which resulted in a court “piercing the corporate veil” and requiring an individual business owner to write a large check from his or her personal bank account, take note and learn from that situation. But at the same time, recognize that it is a unique occurrence. If you are a business owner or otherwise have one or more legal entities through which you run investments or another enterprise, do what you can to keep good records, hold annual meetings, have your CPA continue with proper accounting and do those other things your attorney has advised you to do to qualify for the desired legal liability firewall protection. Then, when you have done those things, take a deep breath and realize that it is quite unlikely that (a) you will be subject to a legal claim and (b) if you were to be so unfortunately, if you have done your part (and your accountant and attorney have done their parts), your LLC or corporation should do its job to protect you and your personal assets. By the way, while most of the case-law and discussion is in the context of corporations, LLC law and courts applying the same tend to analyze cases of corporations and LLC in a very similar way in most instances.

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