Piercing the corporate veil

Piercing the corporate veil or lifting the corporate veil is a legal decision to treat the rights or duties of a corporation as the rights or liabilities of its shareholders. Usually a corporation is treated as a separate legal person, which is solely responsible for the debts it incurs and the sole beneficiary of the credit it is owed. Common law countries usually uphold this principle of separate personhood, but in exceptional situations may "pierce" or "lift" the corporate veil.

A simple example would be where a businessperson has left their job as a director and has signed a contract to not compete with the company they have just left for a period of time. If they set up a company which competed with their former company, technically it would be the company and not the person competing.[1] But it is likely a court would say that the new company was just a "sham" or a "cover" and that, as the new company is completely owned and controlled by one person, the former employee is deliberately choosing to compete, placing them in breach of that non-competing contract.

Despite the terminology used which makes it appear as though a shareholder's limited liability emanates from the view that a corporation is a separate legal entity, the reality is that the entity status of corporations has almost nothing to do with shareholder limited liability.[2] For example, English law conferred entity status on corporations long before shareholders were afforded limited liability. Similarly, the United States' Revised Uniform Partnership Act confers entity status on partnerships, but also provides that partners are individually liable for all partnership obligations. Therefore, this shareholder limited liability emanates mainly from statute.[2]

Basis for limited liability

Corporations exist in part to shield the personal assets of shareholders from personal liability for the debts or actions of a corporation. Unlike a general partnership or sole proprietorship in which the owner could be held responsible for all the debts of the company, a corporation traditionally limited the personal liability of the shareholders.

Piercing the corporate veil typically is most effective with smaller privately held business entities (close corporations) in which the corporation has a small number of shareholders, limited assets, and recognition of separateness of the corporation from its shareholders would promote fraud or an inequitable result.

There is no record of a successful piercing of the corporate veil for a publicly traded corporation because of the large number of shareholders and the extensive mandatory filings entailed in qualifying for listing on an exchange.

Germany

German corporate law developed a number of theories in the early 1920s for lifting the corporate veil on the basis of "domination" by a parent company over a subsidiary. These cases have led to an encompassing codification of group law provisions in the AktG 1965 (§§ 291 - 319 AktG). By contrast, a general doctrine of piercing the veil for abuse of the legal personality of the company has never really taken hold in Germany. It was advocated in the fundamental work of Rolf Serick,[3] but rejected by the prevailing "Normanwendungslehre".[4] After a few early cases, the German judiciary did not go down the route of establishing shareholder liability via piercing the veil. In particular, it rejected piercing the veil on grounds of material undercapitalization several times.[5] Today, the only remaining case of shareholder liability via piercing of the corporate veil is the inextricable commingling of the assets of the company and the shareholder ("Vermögensvermischung").[6] But shareholders can be held liable in tort (§ 826 BGB) in the case of an interference destroying the corporation ("existenzvernichtender Eingriff").[7]

United Kingdom

The corporate veil in UK company law is pierced very rarely. After a series of attempts by the Court of Appeal during the late 1960s and early 1970s to establish a theory of economic reality, and a doctrine of control for lifting the veil, the House of Lords reasserted an orthodox approach. According to a 1990 case at the Court of Appeal, Adams v Cape Industries plc, the only true "veil piercing" may take place when a company is set up for fraudulent purposes, or where it is established to avoid an existing obligation.[10] However, cases were rare and their justification in light of the Salomon principle remained doubtful. In VTB Capital,[11] Lord Neuberger sympathised with rejecting the doctrine altogether, but left the issue undecided because it did not matter for the outcome. Soon afterwards, in Prest v Petrodel,[12] a divorce case where the matrimonial home was not held by the husband but by his company, the Supreme Court confirmed the existence of the doctrine in English law, but narrowed it down to practical irrelevance.[13] The "fraud exception"[14]

United States

In the United States, corporate veil piercing is the most litigated issue in corporate law.[39] Although courts are reluctant to hold an active shareholder liable for actions that are legally the responsibility of the corporation, even if the corporation has a single shareholder, they will often do so if the corporation was markedly noncompliant with corporate formalities, to prevent fraud, or to achieve equity in certain cases of undercapitalization.[40][41]

In most jurisdictions, no bright-line rule exists and the ruling is based on common law precedents. In the United States, different theories, most important "alter ego" or "instrumentality rule", attempted to create a piercing standard. Mostly, they rest upon three basic prongs—namely:[42] However, the theories failed to articulate a real-world approach which courts could directly apply to their cases. Thus, courts struggle with the proof of each prong and rather analyze all given factors. This is known as "totality of circumstances".[43]

See also

• Veil of Isis § Parting the veil
• US corporate law
• UK company law