When a shareholder is held personally liable for the actions of the corporation it is called?

What happens when a corporation loses a lawsuit but does not have the funds to pay the plaintiffs? If this happens, then the plaintiff may have the right, under some limited circumstances, to go after the personal assets of corporate management or ownership. When the owners and managers of a corporation are found personally liable for a corporation's debts it is known as "piercing the corporate veil."

What is the "Corporate Veil?"

A corporation is a "legal fiction" or "legal personality" created by the incorporators through the legal process of incorporation. It is an organization created by law that is distinct from its members or legally separate from its founders, employees, stockholders, or investors. A corporation can act like an individual, but has certain advantages over an individual in areas like taxation and legal liability.

One of the functions or purposes of creating a corporation is to shield corporate officers, directors, employees and shareholders from civil and criminal legal liability for actions taken on behalf of the corporation. This shielding function is sometimes called the "corporate veil."

The corporate veil separates the assets and liabilities of the corporation from the assets and liabilities of any officers, directors, shareholders, and employees of the corporation. Under normal circumstances, the shareholders and employees of the corporation will not be liable for the debts or obligations of the corporation itself.

Under some limited circumstances, however, this corporate veil can be lifted, allowing legal recourse against individuals for actions taken behind the corporate veil. This is called "piercing" or "lifting" the corporate veil.

Once a court order lifts the corporate veil, individuals who may have committed actions that could give rise to civil legal liability can be sued. At that point, the individual will be responsible for actions undertaken on behalf of the corporation. These actions could be for any number of activities undertaken by an individual under the corporate shield, including tax evasion; criminal, harmful environmental acts; money laundering; and theft.

Civil actions to pierce the corporate veil and go after individual assets are often part of post-judgment collections efforts.

Plaintiffs generally bring civil actions to pierce a corporate veil after they have exhausted every possible action against the main corporation to collect a court judgment. They are usually unable to collect because the corporation does not have the assets to pay. At that point, plaintiffs go looking for money from the corporation's owners and managers and seek court orders to collect from those individuals. In order to make such an order, a court needs to pierce the corporate veil.

How does the corporate veil get lifted or pierced?

In the United States, there is no one statute, legal precedent, or legal theory a plaintiff can use to try to convince a court to lift a corporate veil. Each case is decided on its own facts. Because of this, other legal theories like fraud, theft, and violation of fiduciary duties need to be proven as a basis for allowing individual liability for an act seemingly taken on behalf of the corporation.

This is one reason why this issue is the most litigated legal problem in corporate law.

Common Reasons Courts Allow Piercing of the Corporate Veil

The following are among the most common reasons courts will allow a plaintiff to pierce a corporate veil and impose liability on the corporation's owners and managers.

Injurious Actions

The most common reason for a plaintiff to try to pierce the corporate veil is because a direct action of the corporation's owners, managers, or employees caused injury to the plaintiff. Causes of action for this harm arise from fraud, injustice, or wrongdoing that causes injury to a third party outside of the corporation. This is an action can be taken by an individual without the knowledge of other people in the corporation or while colluding with others in the corporation.

Not Separating Accounts

Another common cause for a plaintiff asking to pierce the corporate veil is a failure of the defendant to keep corporate accounts separate or operating at "arm's length." This generally happens when the owners' and managers' money is intermingled with corporate funds in personal or business bank accounts.

This can take place in instances where there is a parent company and subsidiary companies. The parent controls everything about the subsidiary. They have the same address, corporate officers, corporate information, and they file taxes as the same entity. But they are separate corporations. If one of the subsidiary corporations gets sued and does not have the money to pay the judgment, courts may allow the plaintiff to pierce the corporate veil and claw the money out of the parent company.

Personal and Business Interests Are Too Close

The third type of situation where a corporate veil can be pierced, and a common one, is in the case of a personal LLC, like a doctor's office or a small laundromat. The office needs to run a set of books that is separate from the personal accounts of the doctor or laundromat owner. If the office cannot pay a judgment because the business owner is using office funds as personal funds, that is a classic situation where the LLC corporate veil can be pierced to allow the plaintiff to access the business owner's personal funds.

This is due to the use of a corporation as an ower's "alter ego, where the corporation is used as a façade for the personal dealings of a major stockholder or owner. Evidence of this is an intermingling of corporate assets (funds, real estate, equipment, etc.) with personal assets. A related concept is when a dominant stockholder siphons off funds from the corporation into a personal account or uses corporate funds to pay for personal expenses (which also qualifies as embezzlement, which is a crime).

Inadequate Capitalization

The fourth set of circumstances where a court may allow piercing the corporate veil is when owners fail to adequately capitalize the company. This is not, in and of itself, enough for a court to pierce a corporate veil. If a company loses money or makes bad decisions with its capital, that is just business.

However, courts will look at the corporate account versus the business owner's personal accounts to see if there is an imbalance or if there even is a corporate account in the first place. The court can then determine a result based on fairness toward the plaintiff, which may involve accessing the business owner's personal account.

Adequate capitalization requirements will vary from industry to industry and business to business.

Not Following Corporate Norms

Another common reason to pierce a corporate veil is a simple failure to follow a corporation's organizational formalities. Even a small company has to act like a big company when it comes to following corporate rules. Failure to do so may give a court reason to pierce their corporate veil. A company—even a small LLC-- needs to have regular officer meetings with minutes, properly updated by-laws, properly registered stock, filed all required state reporting, etc.

A lack of corporate records or a set of inaccurate records can trigger an inquiry into whether or not the corporation is acting for the benefit of one individual or a small number of individuals. This includes manipulating assets or liabilities to concentrate them in inappropriate places or to conceal or misrepresent who the stockholders are.

Another red flag is a set of corporate officers or directors who have no function or who perform no function, or a misrepresentation or concealment of members of the company's corporate hierarchy.

Need to Know More About Piercing the Corporate Veil?

If you have questions regarding piercing the corporate veil to hold owners or managers liable for the actions of their corporation, contact a local business attorney who can help you explore your options. Likewise, a business and commercial attorney can help you set up and run a corporation in a manner that is not susceptible to veil piercing.

An officer of a corporation can be on the board of directors or in the company's management team. In fact, an officer can be a shareholder, an employee of the company, someone appointed to the board who may or may not be paid for services rendered, or a person who wears multiple hats under these categories. An officer's personal liability for corporate affairs depends on the facts of the case and the officer's formal relationship to the corporation.

Limited Liability

1. One of the primary features of a corporation is the limited liability protection that incorporation provides. A corporation is an independent legal entity that is formed under state law and exists separately from its shareholders. Limited liability protects shareholders, directors, officers and employees against personal liability for actions taken in the name of the corporation and corporate debts. Ordinarily, an officer of the corporation, whether also a shareholder, director or employee, cannot be held personally liable.

Illegal Activities

1. Of course, if an officer does something illegal or grossly negligent, he can be held personally liable, even if his actions are done under the umbrella of the corporation. Officers who are complicit in misleading the public, lie to the government, bilk investors out of their money, steal corporate resources, embezzle, sexually harass others or do anything else that is illegal may personally face criminal or civil penalties and jail time.

Fiduciary Duties

1. Officers of the board of directors have a legal duty to act in the best interest of shareholders and maximize profits. While an officer of the board enjoys limited liability for actions taken on behalf of the corporation, if he breaches his fiduciary duties and engages in self-dealing or otherwise puts his own interest or the interests of a related party over his duty to the corporation, the officer may be held personally liable.

Piercing the Corporate Veil

1. A court can disregard a corporation's limited liability protections --called "piercing the corporate veil" -- if the court finds that the company is just a shell that allows the people involved to take advantage of creditors. If officers, directors, shareholders or employees treat the corporation as a piggy bank, mingling personal and business funds, and do not comply with the formalities required of a corporation, the court can hold the people involved personally liable.

Good Standing

1. A corporation is incorporated in the state where it files its articles of incorporation. Some states require corporations to file an annual report or pay an annual fee to keep the corporation's registration in good standing. If these obligations are not met in a timely fashion, the state may suspend the corporation's authority to do business in the state. If the corporation allows its state registration to lapse, the people involved risk personal liability exposure if the corporation is sued.