Some types of business entities (most famously, corporations) offer limited liability to their managers, owners, and officers. That is, under most circumstances such parties will have no personal liability for debts incurred (through tort or contract) by the business entity. A “corporate veil”[1] is said to separate the assets of the owners and managers from those of the company. This protection is not absolute, however, and courts will not allow it to protect the perpetrators of a fraud, or where there is no real distinction between a corporation and its shareholder (or director). In such cases the courts may pierce the corporate veil and allow creditors to collect from the personal assets of individuals or entities usually protected by limited liability.[2]
Among the factors considered by courts to determine whether veil-piercing is appropriate are (1) whether it has independent reasons for existence; (2) that it sole purpose is to provide the means of doing the bidding of the individual stockholder; (3) that it was established to perpetrate a fraud; (4) that it is undercapitalized and underinsured given the nature of its business activities; (5) that it holds itself out to the public as the same entity as its parent or other affiliate; and (6) that its managers do not observe proper corporate formalities.[3]
Veil-piercing is a remedy that most courts are highly reluctant to exercise. Indeed, in recent years courts have shifted their focus from corporate formalities (which many small businesses ignore out of ignorance or for efficiency’s sake) and in many states courts will only pierce the veil in cases of fraud or similar wrongdoing.[4] However, some courts continue to conduct veil-piercing analysis by looking to corporate formalities.
LLC Law Monitor discusses a recent case, Kosanovich v. 80 Worcester Street Associates, LLC,[5] in which the Massachusetts Appellate Division upheld a verdict piercing the corporate veil of a limited liability company:
The court’s decision seems inconsistent with the basic rules the court itself cited. As the court said, piercing the veil is intended to remedy fraud, wrong, or injustice. But there was no evidence of any of those. One would have thought the burden of proof would have been on the party claiming that the LLC’s veil should be pierced. The court’s reliance on Feuerman’s inadequate record-keeping effectively placed on his shoulders the burden to prove that he was innocent of violating any of the other 12 factors.
[Emphasis ours]. LLC Law Monitor goes on to note:
Lawyers of course routinely advise their clients to adhere to the various formalities of running a business in the form of a corporation or LLC, and to maintain and keep adequate business and organizational records. This decision drastically underscores the need to follow the formalities and keep good records.
To this we might add that lawyers should be aware of outlier cases like this one and advise their clients to take care where they choose to domicile their business entities, and under what state’s law they choose in forum-selection clauses and the like.
[1] Although traditionally courts refer to the “corporate veil,” the doctrine applies with equal force to other types of business entities. E.g., Fredric J. Bendremer, “Delaware LLCs and Corporate Veil Piercing: Limited Liability Has its Limitations,” Fordham Journal of Corp. and Fin. Law, Vol. 10, No. 2 (2005).
[2] Sea-Land Services, Inc. v. Pepper Source, 941 F.2d 519 (7th Cir. 1991). For a detailed and comprehensive portrait of “veil-piercing” compiled from a dataset of 2,908 cases from 1658 to 2006, see Peter B. Oh, “Veil-Piercing,” Texas Law Review, Vol. 89, No. 1 (2010).
[3] E.g., Skouras v. Admiralty Enter., Inc., 386 A.2d 674 (Del. Ch. 1978); Gebelein v. Perma-Dry Waterproofing Co., 6 Del. J. Corp. Law 309 (Del. Ch. 1982); Papendick v Bosch, 410 A.2d 148 (Del. 1979); Pauley Petroleum Co. v. Continental Oil Co., 239 A.2d 629 (Del. 1968).
[4] Serio v. Baystate Props., LLC, 60 A.3d 475 (Md. Ct. Spec. App. 2013).
[5] Kosanovich v. 80 Worcester Street Associates, LLC, 2014 WL 2565959 (Mass. App. Div.)