Piercing the corporate veil is an extreme step courts will take only when a corporation is a sham. Courts undertake a delicate balancing act to not disturb the corporate structure, while simultaneously impressing upon business owners the importance of abiding by corporate formalities. Piercing the corporate veil refers to the act of a court piercing through the corporate structure to expose personal liability on its owners.
A court will use several factors to determine whether corporate piercing is appropriate. Chief among these are commingling of assets, history of mismanagement, failure to maintain adequate records, and stripping the corporation of assets. The reasons these factors weigh heavily is because it signals that the owners of the corporation is merely a sham cover up where the owners are attempting to utilize personal liability without the work involved.
There are both pros and cons involved with the traditional corporate piercing. It fosters efficiency by the corporation, ensuring it is run smoothly. It encourages investment, as those investing in a corporation need not worry about a disregard of corporate structure. Additionally, piercing encourages management risk-taking, facilitates stock markets, reduces agency costs, and reduces monitoring costs. On the flip side, it is a moral hazard, discourages extension of credit, provides for insider opportunism, externalization of risks, and may foster shareholder irresponsibility. Piercing has historically occurred more in tort suits than contract suits.
Several alternatives have been advanced to piercing the corporate veil that would not disturb the corporate entity. One such alternative is an insurance requirement, which would protect outside creditors. Another such alternative is minimum capitalization requirement, which would signal that the corporation is committed to maintaining itself. A third alternative is pro rata liability. This would allow the shareholders to bear a pro rata share of liability, thereby diffusing how much would be owed. A final alternative is voluntary insurance, which would insure against losses that should reach personal assets.
Corporate law is complex, and many do not realize that under the present corporate statutes, owners in a corporation can still be exposed to personal liability. Understanding when you may be exposed to a court piercing the corporate structure is important to smooth and efficient running of your corporation. Consulting with an experienced legal team can help you understand how well your corporation is running. Call the Trembly Law Firm at (305) 431-5678 to schedule a consultation.