Generally, corporate shareholders are not liable for the debts or obligations of the corporation, including legal liability for torts or contract actions. Under certain circ*mstances, however, a court will disregard the corporate protections and hold shareholders personally liable. This situation arises when a plaintiff sues the corporate shareholder(s) alleging that the court should pierce the corporate veil of protection and hold shareholders liable for the corporate debts or obligations.
This claim involves the alter ego theory. Under this theory, a plaintiff must demonstrate that the purpose of the business entity is not to carry on business as a separate entity; rather, the corporate entity is simply a shell and should be considered one in the same with the shareholders. That is, the corporation is the alter ego of the shareholders and the limited personal liability protections should be disregarded.
Next Article: Shareholder Direct and Derivative Actions Back to: CORPORATE GOVERNANCE
The court will ask the following questions in evaluating whether to pierce the corporate veil:
Business Formalities - Did the business maintain formalities, such as organizational filings, meeting minutes, etc.?
- Example: I am an officer and director of ABC Corp. I fail to file my state registration documents. I also fail to keep track of corporate records. I do not have established bylaws, and I fail to adhere to default governance rules. All of these facts can demonstrate an intent to use the corporation as a shell entity for my personal business activity.
Business Assets - Did the business owners intermingle personal and business funds or other assets?
- Example: I pay my personal mortgage from the business bank account without noting whether the payment is a dividend or salary compensation. Also, I routinely pay corporate expenses from my personal bank account without noting that my payment is a capital contribution to the corporate entity. This can demonstrate the corporation is a shell.
Business Capitalization - Is the business adequately capitalized or does it have adequate liability protection in place?
- Example: As shareholder, director, and CEO, I routinely distribute any corporate profits to myself as a dividend. I leave very little funds in the corporation to finance operations. Further, I do not purchase liability insurance to cover potential legal liability, such as tort liability. If the court finds that the corporate entity form is intentionally underfunded, it may find that the entity is merely a shell for limited liability purposes.
Stakeholder Functions - Did business members comply with or routinely deviate from their roles and responsibilities?
- Example: I serve as director and officer. I make decisions as officer that should be reserved or the board of directors. I fail to submit major decisions to shareholder votes. This would show that I am not respecting corporate formalities and the entity form is a shell for my personal business activity.
A negative response in any or all of these situations could be grounds for the court to disregard the limited personal liability protections of the corporate entity.
Discussion Question
How do you feel about the limited personal liability of corporate shareholders? What do you think is the justification for affording such personal liability protection? Should a court have the ability to pierce the veil of liability protection? Why or why not? Can you think of any other questions that could be relevant in determining whether the corporation is simply the alter ego of its shareholders?
Practice Question
Clark is a shareholder of ABC Corp. ABC Corp is being sued for the actions of an employee. Identify the conditions under which Clark could be held personally liable for the judgment against the corporation.
- As a general provision, shareholders cannot be held liable for the obligations and debts of the corporations. The liability of the shareholders for company debts is limited to the capital originally invested in the business. However, there are circ*mstances where the shareholders may be held liable for the debts, obligations or fraudulent activities of the corporation. This is known as piercing the corporate veil. Elements that may lead to piercing of the corporate veil include:
- Failure to keep personal assets separate from company assets;
- Failure to adequately capitalize the company;
- Failure to maintain liability insurance;
- Failure to observe corporate formalities.
Related Topics
- Corporate Governance Law (Intro)
- What is Business Governance?
- Berle-Means Thesis
- Corporate Governance Rating Definition
- Who are the members of a corporation?
- Corporate Charter
- Shareholder Register
- Common Stock
- Preferred Stock
- Par Value
- Authorized Shares
- Issued Shares of Stock
- Unissued Shares of Stock
- Outstanding Shares
- Institutional Shares
- Dual Class Shares
- What is a closely-held corporation?
- Close Corporation Plan Definition
- What is a Private Company vs a Public Company?
- What is the role and purpose of the corporation?
- What is the Agency theory of corporate governance?
- Shareholder-Centric Perspective
- Shareholder Value
- What is the Stakeholder theory of corporate governance?
- What is the role & rights of Shareholders in the corporation?
- Shareholder Democracy Definition
- Quorum Definition
- Information Circular
- Straight and Cumulative Voting
- Statutory(Straight)
- Cumulative Voting
- Plurality Voting
- Class Voting Shareholders
- Changing the Voting Rules
- Supermajority (Voting)
- Shareholder Sponsored Proposal
- What are the variations on attributes of Ownership structure?
- Stock Split
- What are the fiduciary duties owed by shareholders?
- When is a shareholder personally liable for corporate obligations?
- Appraisal Rights
- Dissenter's Rights
- Say on Pay Rights
- How can shareholder enforce their rights (direct and derivative actions)?
- Amotion
- What is the process for bringing a Derivative action?
- What are corporate vote Proxies?
- Proxy Statement
- Proxy Fight or Contest Definition & Explanation
- What is Shareholder Activism and the significance of Institutional Investors?
- Activist Investor
- Overview of Board of Directors
- Board Decision Making
- Advisory Board (Observer Directors)
- What is the role of the Board of Directors?
- Board of Trustees
- Board of Governors
- What is the composition of the board of directors?
- Chairman of the Board
- CEO as Chairman of the Board
- Inside Director
- Outside Director
- Outside Director or Non-Executive Director Definition
- Independent Outside Director
- Budget Committee
- Audit Committee
- Compensation Committee
- Nomination Committee (Corporate Board)
- What standards govern the actions of the board of directors?
- Duty of Candor Definition
- Duty of Care (Board of Directors)
- Duty of Loyalty (Directors)
- Self-Dealing
- Board Evaluation Definition
- What is the Business Judgment Rule?
- What is D&O insurance?
- Codetermination (Foreign)
- What is the role of Managers of the corporation?
- What standards govern manager actions?
- Chief Executive Officer (CEO)
- Chief Financial Officer
- Chief Information Officer (CIO)
- Chief Investment Officer (CIO)
- Chief Legal Officer
- Chief Operating Officer
- Chief Risk Officer
- Chief Security Officer
- Chief Technology Officer (CTO)
- What are the primary state and federal corporate governance laws?
- What is the role of the state in corporate governance?
- What is the role of Securities Laws in corporate governance?
- What is the role of the Foreign Corrupt Practices Act in corporate governance?
- What is the Sarbanes-Oxley Act (SOX) effect on corporate governance?
- Sarbanes-Oxley Act (SOX)
- What is the Dodd-Frank Wall Street Reform and Consumer Protection Act effect on corporate governance?
- Corporate Monitors
- What industry organization standards affect corporate governance?
- How do proxy advisory firms affect corporate governance?
- What is the role of ethics in corporate governance?
- What are the major causes of corporate governance issues?
- What are the access to information issues?
- What are decision-making structure issues?
- What are the power struggle or competition issues?
- Holding Company
- What are hostile takeovers and defenses to hostile takeovers?
- Williams Act
- Staggered Board
- Shark Repellent Defenses?
- Poison Pill Defenses?
- Flip Over Poison Pill Definition
- Flip In Poison Pill Definition
- Voting Poison Pill Plan
- Delay-Tactic Defenses?
- Legal Lockup Defenses?
- White Knight and Pac Man Defenses?
- Jonestown Defense
- Lady Macbeth Strategy
- Macaroni Defense
- Yellow Knight
- Back-end Plan Definition
- Backflip Takeover Definition
- Dead Hand Provision Definition
- Kamikaze Defense
- Operating Company Property Company Model
- Whitemail
- Scorched Earth Policy Definition
- Revlon Rule
- What are benefit-alignment issues?
- Cadbury Rules Definition
To start, I've had extensive experience in corporate law, having worked with various companies on their legal structures, governance, and liability issues. Now, diving into the concepts highlighted in the article:
Limited Personal Liability of Corporate Shareholders: This principle is a cornerstone of corporate law, ensuring that shareholders are typically not held personally responsible for corporate debts and obligations. It's grounded in the concept of a separate legal entity for the corporation. Shareholders' liability extends only to their investment in the company.
Piercing the Corporate Veil: This legal concept allows a court to disregard the protections of a corporation, holding shareholders personally liable under specific circ*mstances. The "alter ego theory" becomes relevant here, where the plaintiff must show that the corporation essentially functions as an extension of the shareholders rather than a separate entity.
Factors Considered in Piercing the Veil: Several factors are crucial in evaluating whether to pierce the corporate veil:
- Business Formalities: Did the business maintain proper formalities like organizational filings and meeting minutes? Failure can indicate the corporation is merely a facade.
- Business Assets: Were personal and business funds or assets intermingled? Such commingling suggests the corporation is a shell.
- Business Capitalization: Was the company adequately funded or protected against liabilities? Insufficient funding may indicate the corporation exists solely for limited liability purposes.
- Stakeholder Functions: Did members adhere to their roles and responsibilities? Deviations might suggest the corporation is a tool for personal business activity rather than a separate entity.
Personal Liability of Shareholders: Under specific conditions, shareholders can be held personally liable for corporate obligations. For instance, failure to keep personal and company assets separate, inadequate capitalization, lack of liability insurance, and non-adherence to corporate formalities may lead to personal liability.
Regarding the discussion question on limited personal liability, it's a crucial aspect fostering investment and entrepreneurial risk-taking. Shielding shareholders encourages economic growth by allowing them to invest without fearing excessive personal exposure. However, abuses leading to evasion of legitimate obligations warrant measures for courts to pierce the veil. Additional questions determining the corporation's alter ego might involve the nature of decision-making authority, adherence to accounting standards, and transparent governance.
The topics surrounding corporate governance and law are vast and interconnected, covering everything from shareholder rights and duties to the composition and functions of the board of directors, as well as broader issues like ethics, decision-making structures, and defenses against hostile takeovers.
If you'd like a deeper dive into any specific aspect or have further questions, feel free to ask!
