Key Takeaways

  • Piercing the corporate veil allows courts to hold LLC or corporate owners personally liable for business misconduct.
  • Courts look for misuse of corporate form, fraud, undercapitalization, and lack of formalities.
  • Closely held businesses and single-member LLCs are especially vulnerable.
  • Proper separation of business and personal finances, formal documentation, and adequate capital are essential to maintain liability protection.
  • Courts are cautious and selective when piercing the veil; it typically occurs only under egregious circumstances.

What Does It Mean to Pierce the Corporate Veil?

Piercing the corporate veil is when the courts ignore the "corporate veil" placed on an LLC or corporation. A corporate veil is when a business is incorporated so that its owners, shareholders, and employees will not be held personally responsible if the business can't pay its debts. A corporate veil is also known as limited liability.

LLCs and corporations are legally separate from their owners and shareholders — this is what allows the veil to work.

Why is the Ability to Pierce the Corporate Veil Important?

Piercing the veil can help protect smaller businesses from larger ones. For example, if a large business refuses to pay a smaller one for provided services.

Also, it can be used to force corporations to comply with government programs. However, courts are reluctant to pierce the veil. Three major grounds for these cases include:

  • To make a corporation comply with programs like Social Security
  • Manipulating bankruptcy laws
  • Fraud has been committed

Most veil cases are based on these three issues. Find out if these issues are in play before trying to pierce the corporate veil.

What Happens if the Veil is Pierced?

When the corporate veil is pierced by a court, those involved with the corporation may be held liable for its wrongdoing. This can include members of the corporation or LLC, its shareholders, and its owners. The personal finances of these people may be seized in order to pay corporate debts. Creditors may pursue houses, personal bank accounts and investments, and any other assets of value.

However, when the veil is pierced, the court will only hold people liable who are proved to be responsible for the corporation's wrongful action. Anyone innocent of misdeeds will not be responsible for the corporate debt.

Reasons to Consider Piercing the Corporate Veil

There are some reasons you might need to pierce the veil:

  1. A business may have committed fraud. Fraud is the top reason to pierce the veil. For example, if a business shuts down to avoid paying debts, this is fraud. Piercing the veil may be the only way to get your money after fraud has happened.
  2. Corporations must maintain their different identities. This means they need to have their own finances, owners, and buildings. If they don't, they have not separated properly. The veil may need to be pierced in this circumstance.
  3. Companies must also be separate from their shareholders and owners. This is slightly different than companies being separate. For instance, if an owner is using business money like personal money, they have not separated from their company.
  4. If business does not maintain enough capital, the veil may need to be pierced. A lack of money prevents a business from paying their lenders. It may also keep it from paying employees. Intentionally low capital is a main reason to pierce the veil.
  5. Corporate formality should be followed. This includes annual meetings, keeping full records, and adopting bylaws. Corporations that don't follow these rules may have their veil pierced. Lack of formality is a red flag to courts.

Piercing the veil is not necessarily punishment. It can even be a tool to encourage businesses to run properly. A pierced veil can encourage investment and smoother functioning. There are very good reasons to pierce the corporate veil.

Factors Courts Consider When Piercing the Veil

Courts typically analyze multiple factors before deciding to pierce the corporate veil. These include:

  • Commingling of Assets: When business and personal assets are mixed—such as using company funds for personal expenses—it suggests the company is not truly independent.
  • Failure to Follow Corporate Formalities: Skipping steps like annual meetings, keeping records, or issuing stock certificates can undermine the corporation’s legitimacy.
  • Undercapitalization: If a company is formed without sufficient funds to meet its liabilities, courts may view it as a sham entity.
  • Alter Ego Doctrine: If the corporation or LLC is merely a façade for the individual’s personal dealings, courts may determine that limited liability should not apply.
  • Use of the Entity to Commit Fraud: Courts are more inclined to pierce the veil when the entity was used to engage in fraudulent or wrongful conduct.

Reasons You Shouldn't Pierce the Corporate Veil

Sometimes, piercing the veil is not the right decision. Courts don't like to do it because it signals a sham company. This can hurt the economy and consumer trust. Several alternatives have been proposed to limit the practice.

Required insurance would lower the risk of veil piercing. Voluntary insurance has been proposed for the same reason. If all shareholders held some liability, this could also eliminate the need to pierce the veil. Finally, mandating a minimum capital level should prevent piercing the corporate veil.

Adopting these practices can limit veil piercing. This strengthens both companies and the economy.

Common Mistakes Businesses Make that Expose Them to Liability

Businesses should work to maintain their veil. This depends on avoiding common mistakes. Being aware of these risks can help you avoid them. Avoid liability by:

  • Not Asset Mixing: A corporation is a legal person. This means it has its own assets. Never mix personal and business assets. Doing so may lead to your veil being pierced.
  • Presentation: Always present your business as a business. Design appropriate signage. Print business cards solely for the business. Think about a logo. These all signal a properly run business. It also shows separation from the owner.
  • Records: Clear records will maintain your veil. This is especially true for financial records. Missing or unclear records are a warning sign to Courts. They can indicate asset mixing or other bad actions. Be vigilant about record keeping.
  • Formalities: As mentioned, corporate formality is important. Following this rules shows you are doing things the right way. Hold annual meetings. Follow your adopted bylaws. Do everything possible to follow corporate formality.
  • Lack of Capital: Voluntarily maintain a minimum capital level. This shows you care about paying your creditors. Although not illegal, low capital can put your veil at risk.
  • Pay Shareholders: Courts will pierce your veil if you don't pay your shareholders. This should always be a priority. Not regularly paying shareholders is a big mistake to avoid.

Who Is Most at Risk of Veil Piercing?

Not all businesses face the same level of risk when it comes to piercing the corporate veil. Courts are more likely to pierce the veil in:

  • Closely Held Corporations: These are businesses with few shareholders, often family-owned or managed by a single individual.
  • Single-Member LLCs: Owners may fail to maintain the separation between personal and business affairs.
  • New or Insolvent Companies: Businesses without adequate capital or those facing persistent insolvency may raise red flags.
  • Parent-Subsidiary Structures: If a parent company controls a subsidiary to such a degree that the latter has no independent will, the court may find them indistinguishable.

Piercing the Corporate Veil FAQ

  • What is the Alter-Ego Theory of Liability?

Alter-Ego Theory is used for fraudulent corporations. Corporation cannot be used for personal business. If it is, it is the alter-ego of its owners and shareholders. This opens them to liability. An example of this is a parent company fully controlling its subsidiary. Businesses should be separate from their owners and shareholders. Alter-ego theory can be used to pierce the veil. This also applies to LLCs.

  • How Can I Protect My Assets?

Fortunately, protecting your assets is easy. All you have to do is follow rules for maintain a corporation. Maintain corporate or LLC formality. Avoid low capital levels. Document business actions and finances. Keep personal and corporate assets separate. Make your corporate or LLC status clear. These best practices will protect your assets and maintain your corporate veil.

Examples of Piercing the Corporate Veil

  • Edwards Company, Inc. v. Monogram Industries, Inc: In this case, Edwards sued Monogram for debt owed by their subsidiary company, Monitronics. Edwards claimed Monitronics only existed on paper and that their debt belonged to Monogram. They sought to pierce the corporate veil. It was denied because the court could find no fraud and it could not be proven that Monogram and Monitronics were the same company.
  • Doberstein v. G-P Industries, Inc: This case is interesting for how it was decided. G-P Industries was hired to remodel a home. They could not finish the job because of financial losses. Doberstein sued them for their failure to complete the project. Fraud is the main charge in this case. Although G-P may have acted unscrupulously, no fraud was found, so they won the case.

Steps to Avoid Liability

The main reason for a corporation or an LLC is to avoid personal liability. However, even with your veil in place, liability is still a possibility. Here is a checklist to help you avoid liability:

  • Sign documents and contracts with your business title.
  • Personal and business assets should never mix. Don't pay corporate expenses with personal money. Also, don't use corporate money for your own benefit.
  • Hold annual meetings — this includes shareholder meetings. Regularly meet with your board of directors.
  • Maintain a company record book. Include meeting minutes. Also, fully detail financial transactions.
  • File annual reports with the Secretary of State and do so in a timely manner.
  • Always know where your founding documents are. These can include incorporation articles and bylaws. You should also maintain an ownership ledger.
  • Register every name you use for your business. Submit registration to the Secretary of State and county recorders.
  • Register your business in every state where you operate.
  • Understand the rules for operating everywhere you do business.

Finally, make sure to hire an attorney. An experienced attorney can help you avoid liability. They can also give you tips for protecting your corporate veil.

Additional Strategies to Preserve Limited Liability

In addition to standard compliance steps, companies can further safeguard the corporate veil with these best practices:

  • Document Major Business Decisions: Keep minutes for all major resolutions, especially those involving financial matters.
  • Use Clear Contracts: Ensure contracts specify that the agreement is with the corporation or LLC—not the individual owner.
  • Avoid Informal Agreements: Even among friends or family, conduct business formally to establish the legitimacy of the entity.
  • Get Adequate Insurance: While insurance doesn’t prevent veil piercing, it can cover liabilities and protect owners financially.
  • Regular Financial Audits: Third-party reviews of financial statements demonstrate good-faith business operations and transparency.

Frequently Asked Questions

1. What are the most common reasons courts pierce the corporate veil?Fraud, undercapitalization, failure to follow corporate formalities, and commingling of personal and business assets are the leading causes.

2. Can the corporate veil be pierced for a single-member LLC?Yes. Single-member LLCs are particularly vulnerable if the owner fails to maintain clear separation between personal and business affairs.

3. Is piercing the corporate veil considered a punishment?Not exactly. It’s a legal remedy used to ensure fairness and prevent abuse of the corporate structure.

4. What evidence is needed to pierce the corporate veil?Courts look for patterns of misconduct—such as financial mismanagement, lack of records, and fraudulent intent—not just isolated incidents.

5. Can veil piercing apply in contract disputes or only in fraud cases?While more common in fraud cases, courts may pierce the veil in contract disputes if there’s sufficient evidence of misuse of the corporate entity.

Learn More From an Experienced Attorney

Maintaining or piercing the corporate veil is easier when you have legal help, which is why you need an UpCounsel attorney. If you're thinking about incorporating or forming an LLC, we can help with the process. If you are seeking to pierce the corporate veil, we can examine your case and let you know if piercing the veil is possible.

On the UpCounsel marketplace, you'll find countless, knowledgeable attorneys ready to help with your case. You'll also be able to get great pricing rates and will be able to find a great attorney from the comfort of your own home. Contact UpCounsel today to learn how you can get the legal help you need.