Scaring the Shareholder

The issue of piercing the corporate veil seems to be gaining a lot of notice lately. Here, in a nutshell, is the issue:

1. As a general rule, a business that is operated under the corporate form (or as a limited liability company) has limited liability.
2. “Limited liability” means that the assets available to satisfy a judgment creditor are limited to the assets in the business itself. The owner of the business, in other words, is not personally liable to judgment creditors. So, by way of illustration, if a creditor gets a $1,000,000 judgment against Donald Trump LLC, it can only go after the assets of the LLC–not Donald individually.
3. There are exceptions to this rule of limited liability. A shareholder, for instance, might have personally committed the tort. Or maybe the shareholder personally guaranteed a corporate debt. Those are pretty obvious.
4. But there’s another exception: If the corporation (or LLC) is basically a sham, a creditor might be able to argue that the corporation/LLC should be treated as though it doesn’t exist, with the result that the shareholder/member should be held personally liable for the corporation’s/LLC’s obligations. This is called “piercing the corporate veil.”

The test for whether a court will pierce the corporate veil is pretty vague. I remember one law professor saying, “If the judge feels bad for the creditor, or for some reason is mad at the shareholder, he’ll pierce.”

I’m not quite that cynical, but the professor’s point has merit. The test is too vague to give certainty to any business client. A recent case out of Indiana (CBR Event Decorators, Inc. v. Todd M. Gates, 962 NE2d 1276 (2012)) illustrates the amorphous nature of the doctrine.

The court reiterated the eight traditional factors that courts look at when determining whether to pierce the corporate veil:

1. Under capitalization;
2. Absence of corporate records;
3. Fraudulent representation by the corporation, shareholders or directors;
4. Use of the corporation to promote fraud, injustice, or illegal activities;
5. Payment by the corporation of individual obligations;
6. Co-mingling of assets and affairs;
7. Failure to observe required corporate formalities;
8. Other shareholder acts or conduct ignoring, controlling, or manipulating the corporate form.

They seem straightforward enough, but if you reflect on many of them (especially number 8), you quickly realize that these factors can be manipulated and applied in almost any fashion. To worsen the situation, the court noted the eight factors listed above are not exhaustive and that not all the factors need to be found in order to pierce.

The court then stated that piercing is appropriate if “the misuse of the corporate form would constitute a fraud or promote injustice.”

And that, quite frankly, almost seems to return the analysis to the law professor’s jaundiced opinion.