Understanding How Courts Pierce the Corporate Veil
A completely legitimate purpose of incorporation is to limit or eliminate the personal liability of corporate principals. See, e.g., Miranco Contracting, Inc. v. Perel, 57 A.D.3d 956, 958, 871 N.Y.S.2d 310, 313-14 (2d Dep’t 2008). Indeed, perhaps the most important way that incorporating protects individual entrepreneurs is to insulate them from personal liability for business debts. But that protection can be lost through a process known as “piercing the corporate veil” if the corporate principals engage in improper business practices in asserting their control over the corporation.
In general, a court can pierce the corporate veil, thus allowing a creditor to recover from the principals personally debts incurred on behalf of the corporation, if the creditor shows, among other things, a “sufficient unity of interest and ownership that the separate personalities of the individual and the corporation no longer exist.” Misik v. D’Arco, 197 Cal. App. 4th 1065, 1073, 130 Cal. Rptr. 3d 123, 129 (2d Dist. 2011); see also Miranco Contracting, 57 A.D.3d at 958, 871 N.Y.S.2d at 314 (the individual defendants must have “exercised complete domination and control over the corporation”). This part of the test for piercing the corporate veil encompasses a series of factors that were catalogued in Associated Vendors, Inc. v. Oakland Meat Co., 210 Cal. App. 2d 825, 838-40, 26 Cal. Rptr. 806, 813-15 (1962), a case that is still followed in California, see, e.g., Zoran Corp. v. Chen, 185 Cal. App. 4th 799, 811-12, 110 Cal. Rptr. 3d 597, 606-07 (6th Dist. 2010) (review denied). See also Fantazia Int’l Corp. v. CPL Furs N.Y., Inc., 67 A.D.3d 511, 512, 889 N.Y.S.2d 28, 29 (1st Dep’t 2009) (listing similar factors considered under New York law).
While the list of factors is varied and quite extensive (See, Piercing the Corporate Veil: A Rare and Drastic Result), the test boils down, in large part, to the court ensuring that, after incorporation, the firm’s business was treated as belonging to the corporation rather than to its individual owners. To that end, the court will inquire into such matters as whether corporate funds were segregated in separate bank accounts and never commingled with individual assets or diverted to anything other than corporate uses, such as paying an individual shareholder’s debts. Did the corporation have its own business address, separate from that used by an individual owner if he maintained another business of his own after incorporation? Were corporate formalities strictly followed at all times—for example, were stock certificates prepared in the manner specified by law and actually issued to all shareholders? Were shareholders’ and directors’ meetings held regularly, especially to approve important business decisions? Were minutes of all such meetings properly maintained?
While piercing the corporate veil is a rare result, the consequences can be quite drastic, as evidenced by the outcome in Krausz Puente LLC v. Westall, No. B164989, 2005 WL 236862 (Cal. Ct. App. 2d Dist. Jan. 25, 2005) (unpublished). In that case, the corporate principals used several interrelated corporations to operate their gaming business. One of the corporations leased space from the owner of a shopping mall, who also provided financing to build out the space. When the lessee corporation defaulted on the lease, the lessor sought to pierce the corporate veil and hold the principals individually liable for all of the business’s debts to him. The court analyzed the case under Associated Vendors, noting that many of the factors were evident, including that: the two principals controlled all three corporations and occupied virtually the same positions in each company; both of them treated the corporations’ assets as their own by paying personal expenses out of corporate funds; the corporations’ funds were commingled with each other, and assets were diverted from one corporate entity to the next; all of the corporations were undercapitalized; and financial records and corporate minutes were not properly maintained, even as to the most significant events in the history of the companies. Based on these improper business practices, the court affirmed a judgment holding the principals personally liable for more than $4.5 million of their corporations’ obligations. See also Stinky Love, Inc. v. Lacy, No. B163377, 2004 WL 1803273 (Cal. Ct. App. 2d Dist. Aug. 13, 2004) (unpublished) (affirming $4.3 million judgment against corporate principal who, among other things, used the corporation’s assets to pay off his personal debts, including credit cards and automobile loans, shared office space and employees between the corporation and other entities he controlled, and moved money freely between his bank accounts and those of the corporation). The lesson is clear: the separate “personalities” of the corporation and its individual owners must be respected in order to maintain the protection of the owners’ personal assets ordinarily afforded by the incorporation process.
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