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PIERCING THE CORPORATE VEIL

Introduction

Definition: Piercing the corporate veil - Process of imposing liability for corporate activity, in disregard of the corporate entity, on a person or entity other than the offending corporation itself. There are times when the court will ignore the corporate entity and strip the organizers and managers of the corporation of the limited liability that they usually enjoy. In doing so, the court is said to pierce the corporate veil. The S Corporation provisions pierce the corporate veil and allow the income to be taxed to the shareholders. The Collapsible Corporation rules also pierce the corporate veil.

Corporations are created to protect the principals from being held personally responsible for the debts and liabilities of the corporation. That protection allows a situation where creditors can lay claim to a corporation's assets, but not the personal assets shareholders of the corporation. In some circumstances, those creditors will attempt to "pierce the corporate veil." This is the legal term used to describe an action to have the corporation opened up in order to allow a creditor to lay claim to the personal assets of the protected corporate shareholders.

Civil litigation is the usual vehicle for this legal maneuver. The plaintiff will allege that the corporation is not really a truly distinct entity and or the shareholders are really trying to use the entity fraudulently. This tactic is normally undertaken when the corporation’s assets seems to be insufficient.

Piercing the Corporate Veil can happen when (“Piercing The Corporate Veil,” http://www.residual-rewards.com/piercingthecorporateveil.html):

• corporate debt is knowingly incurred when the company is already insolvent;

• required annual shareholders or board of directors meetings are not held, or other corporate-formalities are not observed;

• corporate records, especially minutes of directors meetings, are not properly or adequately maintained;

• shareholders remove unreasonable amounts of funds from the corporation, endangering its financial stability;

• there is a pattern of consistent non-payment of dividends, or payment of excessive dividends;

• there is a general commingling of corporate activity and/or funds and those of the person or persons who control the corporation;

• there is a failure to maintain separate offices, the company has little or no other business and is only a facade for the activities of the dominant shareholder who is in fact, the corporate "alter ego."

Piercing the Corporate Veil in the Real World

In the business world, piercing the corporate veil happens relatively frequently. These cases are usually are becoming more acceptable and as such should be headed as a warning to managers and shareholders to properly run their organizations. Some of these cases have created precedents.

Some popular cases are:

• Church of Scientology of California and the IRS (1981 вЂ" Tax Exemption)

• Strangi vs. IRS

• Milwaukee Toy Co. v. Industrial Comm'n of Wis., (1931).

• Associated Vendors, Inc. v. Oakland Meat Packing Co. in 1962

Factors for Courts to Consider (Wikipedia)

• Significant undercapitalization of the business entity (capitalization requirements vary based on industry, location, and specific company circumstances)

• Failure to observe corporate formalities in terms of behavior and documentation

• Intermingling of assets of the corporation and of the shareholder

• Treatment by an individual of the assets of corporation as his/her own

• Failure to pay dividends

• Siphoning of corporate funds by the dominant shareholder(s)

• Non-functioning corporate officers and/or directors

• Concealment or misrepresentation of members

• Absence or inaccuracy of corporate records

• Was the corporation being used as a "faÐ"§ade" for dominant shareholder(s) personal dealings; Alter Ego Theory

• Failure to maintain arm's length relationships with related entities

• Manipulation of assets or liabilities to concentrate the assets or liabilities

• Other factors the court finds relevant

**It is important to note that not all of these factors need to be met in order for the court to pierce the corporate veil. Further, some courts might find that one factor is so compelling in a particular case that it will find the shareholders personally liable

Strength and Weakness of the Piercing the Corporate Veil

Overall, it is clear that a correctly formed, maintained and reported corporation probably will not encounter the issue of Piercing the Corporate Veil, but corporations are not always formed for honest gain. Some are formed in order to shelter assets from the IRS and others are formed in order to take advantage of multiple benefits. In the end, one forms a corporation to take advantage of something that will create benefit for the shareholders. It is not a crime to do so, but take care that the use of this entity requires due diligence in order to maintain it integrity.

Maintaining the integrity of a corporation breaks down into, roughly, three parts: Corporate Formalities вЂ" Proper Procedures; Individual Control - Financial interest/ownership corporation; Personal Use - Personal purposes.

Clearly, a corporate organization is vulnerable to these three main issues if a majority of ownership is placed in one person’s hands. It should be noted that in a case where an organization