The Principle of Limited Liability - June 12 Flashcards
Is a corporate entity solely liable for the actions or debts of the corporation? (Q)
Yes. A corporate entity is solely liable for the actions or debts of the corporation due to its status as a legal person. The shareholders’ individual liability is typically limited to the amount of their respective corporate contributions.
May creditors reach the personal assets of corporate officers, directors, and shareholders who have committed wrongful acts? (Q)
Yes. Creditors may reach the personal assets of corporate officers, directors, and shareholders who have committed wrongful acts. This is referred to as piercing the corporate veil of limited liability. Courts may pierce the corporate veil by setting aside the principle of limited liability and disregarding the corporate entity in the interests of equity. However, piercing the corporate veil is a drastic and rarely granted remedy.
If a corporate veil is pierced, can a corporation’s officers, directors, and shareholders be held individually liable for a corporation’s actions or debts? (Q)
Yes. If a corporate veil is pierced, the corporation’s officers, directors, and shareholders can be held individually liable for the corporation’s actions or debts. It is also possible to pierce the corporate veil of a subsidiary corporation to hold its parent corporation liable for the subsidiary’s acts.
What is the alter-ego theory? (Q)
The alter-ego theory, also known as the instrumentality doctrine, provides that a court may pierce the corporate veil if the corporation is a mere instrumentality, or alter ego, of a controlling shareholder. In order to pierce the corporate veil under this theory, a court must find that (1) the corporation and the controlling shareholder are operating as a single economic entity, and (2) there exists some significant inequity or unfairness.
In deciding whether to pierce the corporate veil, is there a test courts use to determine whether a corporation and a shareholder are functioning as a single economic entity or alter ego? (Q)
No. There is no test that courts use to determine whether a corporation and a shareholder are functioning as a single economic entity or alter ego. Instead, courts consider various criteria such as whether:
the corporation was undercapitalized,
the corporation was solvent,
the corporation was properly incorporated and maintained corporate records and formalities,
the corporation had a properly functioning board of directors,
the corporation’s directors were carrying out their fiduciary duties, and
the controlling shareholder was siphoning funds from the corporation or commingling the shareholder’s and corporation’s assets.
A shareholder may be held individually liable for abusing the corporate form if the corporate entity lacks a separate identity and exists only to shield the shareholder from creditors.
Are courts generally willing to pierce the corporate veil? (Q)
No. Courts are not generally willing to pierce the corporate veil. Courts will typically only pierce the corporate veil if (1) fraud has been committed or (2) the alter ego theory applies because there has been a failure to adhere to basic corporate formalities. Courts are generally more likely to pierce the corporate veil for tort liability than for contract liability.
A man filed the necessary paperwork to incorporate his business. The man was the corporation’s sole shareholder and ran the company as the sole officer. The corporation had a board of directors, but the board rarely met. The man opened a bank account for the corporation but frequently paid his personal bills with funds from that account. Every quarter, all corporate profits were disbursed as dividends to the man as the sole shareholder. One day, an employee was driving the corporation’s van and ran a red light, seriously injuring a jogger. Although the van was insured for a small amount, the jogger’s damages significantly exceeded those policy limits. Facing a large damage claim against the corporation, the man decided to dissolve the corporation.
Is it likely that the jogger will be able to pierce the corporate veil and sue the man in his personal capacity? (Q)
Yes. The jogger will likely be allowed to pierce the corporate veil. Generally, the corporate structure protects shareholders from liability for the corporation’s actions. However, this corporate veil may be pierced to expose a controlling shareholder to liability under an alter-ego theory if:
the corporation and the shareholder operated as a single economic entity, and
significant inequity or unfairness will occur if the veil is not pierced.
Here, the man was the sole officer and the board rarely met. The man mixed personal and corporate funds, siphoned off profits, and used corporate funds to pay his personal bills. This means the man and the corporation were operating as a single economic entity. Further, the innocent jogger cannot recover from the dissolved corporation, causing a significant inequity if the veil is not pierced. Thus, the jogger will be able to pierce the corporate veil.
