What does it mean to “pierce the corporate veil”?

Rohan Mathew

One may have seen the phrase “pierce the corporate veil” at some point or another, not fully understanding exactly what the phrase means. Indeed, the phrase has quite a lot of relevance to a corporation’s owners, board of directors, and shareholders, as the situation it refers to affects them in particular. But what exactly does the phrase mean?

Understanding what it means to “pierce the corporate veil”

The act of piercing the corporate veil generally refers to when the protection — the corporate veil — that limits the liability that people at the corporation may have to face is pierced, so to speak, allowing for repercussion to face those such as the owners, board of directors, and shareholders at the corporation. If the corporate veil is successfully pierced, the individuals may be held personally liable for criminal activity. Different states are often going to handle personal liability of people involved in the corporation differently; for example, in Texas, there is a rather narrow range of situations that may allow for the corporate veil to be pierced. Texas used to have a rule called the “Actual Fraud Rule,” which allowed for the piercing of the corporate veil in three scenarios: the corporation is an alter ego of one or more of the above-mentioned individuals; the corporation is being used for illicit purposes; and/or the corporation was created to perpetuate fraud.

One key aspect of a limited liability company (LLC) is that the owners, directors, and shareholders are not personally responsible for the debts or liabilities, serving as a combination of elements from a corporation and elements from a partnership. This is a major advantage of them and has certainly saved more than a few people involved in LLCs from facing legal trouble as a result of issues the LLC is facing. Mind you, while LLCs do have this major advantage, there are disadvantages that may be found as well, especially in some states, so it shouldn’t be assumed that owning an LLC is a walk in the park legally. LLCs are a popular form of business structure used by companies such as hedge funds.

While the potential application of this piercing is more limited than it once was, it still allows for it in the event that the corporation was being used by an owner, director, and/or shareholder to perpetrate fraud, and that the fraud occurred. Specifically, there has to be evidence to show that one or more of these people were attempting to defraud for their personal benefit utilizing the corporation, and the court has to be able to find probable cause that the person or persons accused may have committed this crime. The courts found that the mere act of creating a sham company, or an alter ego was inadequate to justify piercing the corporate veil. Unfortunately for a plaintiff seeking to pierce the corporate veil, doing this in Texas can be somewhat difficult; for instance, a plaintiff cannot sue both an LLC and a person at the same time. This becomes extra problematic due to the fact that such a lawsuit against an LLC can be vital to proving that piercing the corporate veil may be a worthwhile action to pursue for the courts.

One concern that often comes up with LLCs is whether a single-member LLC faces special issues that multiple-member LLCs do not. LLCs located in Texas do not have to worry about this stressor, as no case has been brought against and has successfully used the fact that there is only one member. However, it is understandable that such concern would exist, as cases in other states have had there being only one member affect the outcome of the case.

Despite the fact that there are significant barriers that render the alter ego theory essentially dead in the water most of the time, this does not prevent people from filing them. After all, just because something is not likely to have any success in a court of law does not mean that someone will not attempt to bring it to one. As a direct result of this, it is of vital importance that any business have an experienced Houston business attorney backing up their business. After all, no matter how legitimate you may view your LLC, no matter how safe you may feel that you are from such a lawsuit, having a business attorney helping you keep your ducks in a row makes these lawsuits be over and done with as soon as possible. Be extra diligent with all documentation relating to your company, and while there will be a much greater burden of proof required than someone pointing out that you cut corners on certain aspects of documentation, it doesn’t mean it’s not a good idea to be on top of that.