Friday, October 12, 2012

Corporations Law: Piercing the Corporate Veil outline

 Piercing the Corporate Veil Study Guide

A corporation is normally treated separately from its shareholders. Limited liability means the shareholder’s liability is limited to their investment in the corporation. But under certain circumstances, the corporate veil can be pierced and a claim against the corporation can reach a shareholder’s assets.

Theories for piercing the corporate veil:
  1. Inadequate Capitalization
    1. Usually not enough to pierce the corporate veil when it is the only factor.
    2. This is due to the fact that measuring adequate capitalization is hard.
    3. “Grossly inadequate capitalization combined with disregard for corporate formalities, causing basic unfairness, are sufficient to pierce the corporate veil in order to hold the shareholders actively participating in the operation of the business personally liable…” Kinney Shoe Corp. v. Polan (4th Cir. 1991)
      1. In this case, Polan bought no stock, made no capital contribution, kept no minutes, elected no officers, held no meetings for Industrial, and paid corporate debt out of his personal funds.
      2. This is inadequate capitalization to the extreme. It had no capital. Very easy case.
      3. This corporation was no more than a shell. When nothing is invested, the corporation provides no protection to its owner; nothing in, nothing out, no protection.
  2. Alter Ego
    1. Delaware law permits a court to pierce the corporate veil “where there is fraud or where it is in fact a mere instrumentality or alter ego of its owner”. Fletcher v. Atex, Inc. (2nd Cir. 1995)
    2. To prevail under an alter ego claim, a plaintiff must show:
      1. That the parent and the subsidiary (or shareholder and corporation) “operated as a single economic entity”
      2. That an overall element of injustice or unfairness would result from respecting the two companies corporate separateness.
    3. Among the factors to be considered in determining the existence of a single economic entity are:
      1. Whether the corporation was adequately capitalized;
      2. Whether the corporation was solvent;
      3. Whether dividends were paid, corporate records were kept, officers and directors functioned properly, and other corporate formalities were observed;
      4. Whether the dominant shareholder siphoned corporate funds; and
      5. Whether, in general, the corporation simply functioned as a facade for the dominant shareholder.
  3. Fraud, Misrepresentation, Illegality
    1. It is not fraudulent for the owner-operator of a single cab corporation to take out the minimum required insurance, the enterprise does not become fraudulent merely because it consists of many such corporations (Walkovsky).
    2. The court cannot mandate that a corporation make a profit (Bartle).

Analysis of the cases:
  1. courts look to the specific context more than any inherent corporate characteristic;
  2. the likelihood of piercing increases as the number of shareholders decreases;
  3. “misrepresentation” is the most powerful factor listed by courts when they pierce, followed by “demonstrations of lack of substantive separation of the corporation and its shareholders”, “undercapitalization” and “failure to follow corporate formalities” are other strong factors;
  4. piercing is less likely in tort contexts (involuntary creditor) than in contract cases (voluntary creditor);
  5. piercing is more likely when the defendant behind the corporation is an individual stockholder than when it is another corporation; and
  6. “passive shareholders” are almost never held liable.


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