Piercing the corporate veil refers to a special instance where the court holds the shareholder or director of a corporation personally liable for the corporation’s debts.
Piercing the corporate veil is also known as veil-piercing, disregarding the corporate entity, or lifting the corporate veil. Under the corporate veil, there is a legal separation between the personal assets of the shareholder or director of the corporation itself. Therefore, the personal assets of the shareholders/directors are not under the limited liability of the corporation’s actions that result in debt.
In a piercing the corporate veil case, the court completely disregards the separate entity aspect of a corporation. Generally, the creditor will sue and win against a corporation, then sue the director or the shareholder of the corporation. In suing the individual shareholder or director, the creditor asks the judge to pierce the corporate veil following the corporation’s failure to pay the debt. The practice of veil-piercing is most common for close corporations. Courts typically have a strong presumption against veil-piercing and respect the general benefits of having a limited liability corporation because it "encourages development of public markets for stocks and thus helps make possible the liquidity and diversification benefits that investors receive from those markets." As a result, the courts only allow the piercing of the corporate veil in cases of serious or egregious misconduct that includes the abuse of the corporation for strictly personal purposes.
The standard for veil-piercing differs from jurisdiction to jurisdiction. In most cases, the court looks into the unity of interest test. The unity of interest test examines whether the shareholder or the director used the corporate funds for personal use. Using the corporate assets personally indicates that the shareholder/director does not respect the separate entity of the corporation, allowing the possible basis for veil-piercing.
The courts also examine the undercapitalization of corporations. The corporation may be undercapitalized because the shareholder/director does not intend to carry out the normal business of the corporation. If the shareholder/director does not carry out the everyday business of the corporation, that may be because the shareholder/director holds the corporation for strictly personal purposes.
Finally, the courts may see if the corporation complies with the requirements of corporations, such as retaining business licenses, filing annual reports, etc. If the corporation does not meet the compliance requirements, then the courts may allow veil-piercing.
The piercing of the corporate veil differs from state to state.
In Florida, to pierce the corporate veil, one must generally prove two elements:
- The corporation is only an alter ego or a mere instrumentality of the shareholder, director, or parent corporation.
- The alleged shareholder, director, or the parent corporation engaged in the same misconduct.
In Alaska, the courts use two tests:
- The disjunctive test: for the court to allow veil-piercing, there must be evidence of excessive control or corporate misconduct.
- The conjunctive test: for the court to allow veil-piercing, there must be evidence of both excessive control and corporate misconduct.
Nevada relies on a three-part test:
- The corporation was influenced and governed by the person asserted to be its alter ego.
- There is such a unity of interest and ownership that one is inseparable from the other.
- The facts are such that adherence to the fiction of a separate entity would, under the circumstances, sanction a fraud or promote injustice.
In New York, Walkovsky v. Carlton is the leading case.
- The plaintiff must prove that the shareholder or director used the corporation as their agent for personal purposes.
- The court must also find that the corporation is indeed only the agent of the shareholder or director to find the principal vicariously liable for veil-piercing purposes.
For more on piercing the corporate veil, see this Cornell Law Review article: “Finding Order in the Morass: The Three Real Justifications for Piercing the Corporate Veil” and this Notre Dame Law Review article: “Procedure at the Intersection of Law and Equity: Veil Piercing and the Seventh Amendment”
[Last updated in February of 2024 by the Wex Definitions Team]