Legal Definitions - Piercing the veil

Piercing the veil, often referred to as "piercing the corporate veil," is a legal concept where a court decides to set aside the usual legal distinction between a company and its owners or directors.

Normally, a company is considered a separate legal entity from the individuals who own or manage it. This separation provides limited liability, meaning that the owners (shareholders) are generally not personally responsible for the company's debts or legal obligations. Their personal assets are typically protected if the company faces financial difficulties or lawsuits.

However, in rare and exceptional circumstances, a court may "pierce the veil" to hold the individuals behind the company personally accountable for the company's actions or debts. This extraordinary measure is usually taken when the corporate structure has been abused, used to commit fraud, evade existing legal duties, or engage in other serious misconduct that blurs the lines between the company's affairs and the owners' personal affairs.

Courts are generally very reluctant to pierce the corporate veil because limited liability is a fundamental principle that encourages business investment and risk-taking. They will only do so when there is compelling evidence of egregious behavior, such as:

• Commingling of Assets: When the owners treat the company's money and assets as their own, without maintaining proper separation between personal and business finances.
• Undercapitalization: When a company is formed with clearly insufficient funds to operate its intended business, especially if this is done to avoid potential liabilities.
• Fraud or Misrepresentation: When the company is used as a mere sham or a tool to perpetrate fraud or evade existing legal obligations.

When a court pierces the veil, the personal assets of the owners or directors can become available to satisfy the company's debts or judgments, effectively removing the protection of limited liability.

Here are some examples illustrating when a court might consider piercing the corporate veil:

• Example 1: Disregarding Corporate Formalities and Commingling Funds

  Imagine Sarah owns "Sarah's Sweets," a small bakery incorporated as an LLC. Instead of keeping separate bank accounts, she regularly pays her personal rent, car payments, and grocery bills directly from the bakery's business account. She also deposits personal birthday gift money into the business account. When a customer suffers a severe allergic reaction from a product not properly labeled and sues "Sarah's Sweets," the company's assets are insufficient to cover the damages. A court might find that Sarah has so completely disregarded the separate identity of her business that it was merely an extension of herself. By piercing the veil, the court could hold Sarah personally liable for the customer's damages, allowing the customer to claim against her personal assets, not just the bakery's.

• Example 2: Intentional Undercapitalization to Avoid Liability

  Consider Mark, who decides to start "Mark's Demolition Services," a company specializing in tearing down old buildings. Knowing that demolition work carries high risks of accidents and potential lawsuits for property damage or injury, Mark incorporates the company with only a few hundred dollars in capital and no insurance, despite the substantial risks involved. He intentionally keeps the company's assets minimal. After a major project goes wrong, causing extensive damage to an adjacent property, "Mark's Demolition Services" is sued for millions, but the company has no assets to pay. A court might conclude that Mark deliberately undercapitalized the company from its inception to shield himself from foreseeable liabilities. In this scenario, the court could pierce the veil, making Mark personally responsible for the damages.

• Example 3: Using a Company as a Sham to Evade Existing Debts

  Suppose David owes a significant amount of money to a former business partner based on a court judgment. To avoid paying this personal debt, David creates a new company, "David's Holdings Inc.," and transfers all his valuable personal assets—like his luxury car, investment portfolio, and real estate—into this new company. "David's Holdings Inc." performs no actual business operations; its sole purpose is to hold David's assets. When the former business partner tries to collect on the judgment, David claims he has no personal assets because they are all owned by "David's Holdings Inc." A court would likely see this as a fraudulent attempt to use the corporate structure to evade an existing personal obligation. By piercing the veil, the court would disregard "David's Holdings Inc." as a separate entity and allow the business partner to access those assets to satisfy the judgment.