Trap for Business Owners: Piercing the Corporate Veil

Individuals, acting by themselves or with a group, are generally responsible for their actions; that is, they have general liability for their actions. By forming an entity such as a limited liability company or corporation, each individual in the group can shield himself from general liability, can limit his liability to his investment in the entity. The states permit—or even promote—this as a means of encouraging individuals to take risks and start businesses.

However, under certain circumstances, the limited liability of the entity can be lost; and general liability can extend to its owners. This is known as “piercing the corporate veil” or “piercing the entity veil.” As is the case with many legal issues, the reasons for piercing the entity veil are complicated and vary from state to state. To compound the problem, there are few statutes that govern this issue; individual state law is primarily derived from common law and court decisions.

However, there are issues that commonly run through the individual state laws. The entity veil may be pierced and the limited liability shield of the entity lost, if the owners:

  • fail to incorporate or form the entity
  • abuse the privilege of formation to perpetrate a fraud or injustice or otherwise circumvent the law
  • use the entity as a mere instrumentality of themselves, by
    • commingling personal and entity funds or assets
    • commingling business functions
    • transferring assets without the proper formalities
    • failing to observe corporate formalities
    • deliberately undercapitalizing the entity
    • siphoning entity funds
    • representing themselves to third parties as individuals or partners rather than as officers or members of the entity
    • failing to disclose formation to third parties
    • failing to use the entity nam

As always, please contact me if you have any questions or need additional information.

– Alan N. Walter