Piercing the Corporate Veil: Everything You Need to Know
Incorporating a business is an important step to protect yourself and your personal assets, but understanding potential liabilities is also important2 min read
Incorporating a business is an important step to protect yourself and your personal assets, but understanding potential liabilities is also important. If not done properly, a court might “pierce the corporate veil”, holding you personally responsible for the liabilities of the company. If you are a business executive looking for resources to better understand the risks of piercing the corporate veil in New York, here is what you need to know.
Before a court can assess the potential of piercing your corporate veil, it must first understand the principles of limited liability. Incorporation or forming an LLC is a legal mechanism protecting individuals from personal liability. This means any obligations and debts incurred by the company, known as “business debts”, are only the responsibility of the company itself and the shareholders are not held personally liable. This legal concept is known as “limited liability”.
However, if your limited liability is breached or “pierced”, you may be held responsible for any liabilities that would have otherwise been the responsibility of the corporation or LLC. In the United States, there is no one comprehensive legal test that confirms whether a court will pierce your corporate veil. Thus, in New York, courts base their decision on any combination of the following legal tests.
The "Instrumentality Test" looks at whether the corporation is “more an agent or extension of another entity rather than an independent legal entity”. It is based on a “complete domination” of the corporation, assessing the relationship between the company and its alter ego. If a court concludes the company is merely an extension of yourself, they can easily pierce the corporate veil. Courts often look at indicators such as inadequate capitalization, failure to follow corporate formalities, or a complete lack of corporate records when assessing the potential of misused control.
The “Unity of Interest and Ownership Test” similarly looks at control. It also looks much more closely at the ownership of the corporation and how the ownership is managed. Is ownership shared among many or is there a single owner wielding complete control? Are the owner’s interests complete aligned with the corporation’s interests? By running the company like its own pocketbook, an owner leaves themselves vulnerable to legal challenges to their limited liability.
Courts also assess a company’s economic stature in the “Alter Ego Theory”. In this theory, a company is liable if it is used “as a facade to cover someone’s personal activities”. That is, if a company or its owners are being deceptive or acting fraudulently it could result in piercing the corporate veil.
When determining whether to pierce a corporate veil, courts will look at all three legal theories. However, in New York, courts often rely on the instrumentality test. As with any other legal issue, there is no exact answer. Courts will always assess a case on its fact-specific circumstances.
The idea of limited liability is the cornerstone of the business institution, so it should not be taken for granted. Businesses big and small should always remember that businesses are held on a certain standard of ethics and should be conducted accordingly. With the right legal counsel, you can rest assured that you are in good hands.
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