Reverse Piercing of the Corporate Veil
BY JAY WINSTON & ARTHUR WINSTON, WINSTON & WINSTON, P.C.
The purpose of a corporation is primarily to shelter the shareholders, directors, and officers from personal liability. To take advantage of this umbrella, the officers, directors, and shareholders must operate the corporate entity as a separate corporate entity for the benefit of that corporate entity.
In some instances, the same shareholder controls two different corporations and dominates both corporations to the extent that the corporations, their operations and dealings are all within the control of the one shareholder. Sometimes, one corporation will liquidate or even file bankruptcy, leaving outstanding debts and judgments. Before ceasing business or filing a petition in bankruptcy, the corporation transfers its assets to the other corporation with or without consideration
Sometimes, circumstances present themselves to allow a creditor to pierce this corporate veil and hold that the corporations are alter egos of each other and that the solvent corporation should be liable for the debts of the insolvent or bankrupt corporation. In recent years, suits based on piercing the corporate veil have increased and more and more creditors are recognizing that sophisticated debtors are using this corporate device to avoid payment of their debts.
Piercing the corporate veil is a vague and illusory concept and one of the most confusing applied by the courts in a discriminatory and subjective manner. It is not codified or statutory, but merely a common law creation to prevent a fraudulent use of the corporate umbrella.
When a corporate veil is pierced, the judges usually rely on various theories. The creation of the corporation is a privilege granted by the state and must not be abused. The arrangement between the corporation, the shareholders and creditors is a contractual relationship and this contractual relationship should not be violated.
There are many criteria that the courts identify to justify piercing the corporate veil.
- Are there common shareholders, stockholders, and directors?Does the parent corporation own all or most of the stock of the other corporation or does the individual own the stock in both corporations?
- Does the parent corporation finance a subsidiary or is the subsidiary allowed to use the line of credit of the parent?
- Does one corporation have inadequate capital?
- Does one corporation pay the salaries and the day-to-day expenses of the other corporation?
- Does one corporation have no employees and no day-to-day expenses other than buying and selling merchandise at a profit?
- Does one corporation have no assets and use its income to pay the expenses of the other corporation?
- Does the individual treat the corporation as his own personal business, running personal expenses through the corporation?
- Does the corporation maintain books?
- Does one corporation fail to maintain corporate formality, such as directors’ meetings, shareholders’ meetings, minutes of these meetings, stock transfer books, etc.?
- Is one corporation described by the other corporation as a department or division?
- Did transfers of assets take place from one corporation to the other, rendering the corporation insolvent?
- Was there extensive and pervasive control over the operation of the corporations by one individual?
- Was there commingling of the properties or accounts of the corporation with the other corporation or with the individual?
- Is there an absence of corporate records?
- Is one corporation merely a facade for the personal operations of the dominant shareholder?
- Do the financial statements of the two corporations clearly show overlapping and reliance on each other?
- Are the daily operations of one corporation being maintained by the other corporation?
The above listing identifies certain markers which recur regularly. Unfortunately, no standard has been established to tell you how many of these markers are necessary to induce a particular court to pierce the corporate veil, nor is there any criteria to determine which markers receive heavy consideration. A review of the cases seems to indicate that each judge has his own criteria and each case seems to rest on its own set of facts.
Piercing the corporate veil requires a showing that the parent corporation dominates the subsidiary to such an extent that the latter is really an agent for or an instrumental part of the former, and the parent corporation used that control to commit fraud or some other wrong. A showing is usually required that the dominant party exercises complete control of the corporation with respect to the transactions, and such dominion was used to commit a fraud or wrong against the creditor which resulted in injury to the creditor. Complete domination is the key to piercing