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Piercing The Corporate Veil – When a Stockholder is Liable for the Obligations of a Corporation

Piercing The Corporate Veil – When a Stockholder is Liable for the Obligations of a Corporation

Piercing the Corporate Veil Most Often Occurs in Instances of Fraud or Malfeasance
Despite the general rule that stockholders are not personally liable to creditors of a corporation (the operational meaning of “limited liability”), there are specific circumstances where creditors may “pierce the corporate veil” to satisfy corporate obligations by holding the stockholders personally liable.  The cases generally have permitted the corporate veil to be pierced when fraud or similar malfeasance has occurred, and where it would be manifestly unfair to allow a stockholder to hide behind limited liability.  Thus, it is important to note that the mere incorporation does not automatically prevent creditors of the corporation from reaching the assets of the corporation’s stockholders.

Key Facts Relied on Allow for the Corporate Veil to be Pierced
The following are the primary factors that courts have relied on in allowing the corporate veil to be pierced:

  • Disregard of corporate formalities;
  • Co-mingling of personal and corporate assets or diversion of corporate assets to personal use;
  • “Holding out” to creditors by a stockholder that the stockholder is the obligor;
  • Inadequate capitalization of the corporation; and
  • Manipulation of corporate assets and liabilities by the stockholder.

Suggestions for Maintaining Stockholder Limited Liability
To preserve limited liability for its stockholders, a corporation at a minimum should do the following to treat the corporation as a true separate entity:

  • Obtain and record stockholder and board authorization for corporate actions;
  • Maintain complete and proper records for the corporation separate from the personal records of the corporation’s owners;
  • Make it clear in all contracts with others that they are dealing with the corporation and not any particular individual; for example by using the following signature block format on all contracts and agreements:

“[NAME OF CORPORATION]

By:_________________________________

Title:________________________________”

  • Conduct all transactions between the corporation and its stockholders, officers, and directors on an arms-length basis whenever possible. The Board of Directors should approve any such transaction by a vote of the disinterested directors (or, if all the directors are interested in the transaction, by a vote of the disinterested stockholders), after all the facts material to the transaction have been disclosed; and
  • Start the business with a sufficient amount of equity in light of the future capital needs of the business.

Please contact my office at virginia@virgielaw.com or 530-802-0640 if you would like to further discuss how to protect your personal assets from the liabilities of your business.

Virginia Ryan provides business law services to clients in Northern California, including Auburn, Grass Valley, Nevada City and Truckee.