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By Purple Fox Legal

November 30, 2022

If you’re an entrepreneur, small business owner, or provide business consulting under an LLC in New York or Tennessee, “piercing the corporate veil” is a phrase you need to understand to protect yourself and your business. 

Piercing the corporate veil refers to a situation in which courts put aside limited liability and hold a corporation’s shareholders or directors (or LLC owners) personally liable for the company’s actions or debts. This is most common in closely held organizations, such as corporations or LLCs, which are owned by a limited number of individuals and are not publicly traded.

When Is the Corporate Veil Pierced?

The law for piercing the corporate veil varies state by state. Generally, courts have a strong presumption against piercing the corporate veil and will only do so if there has been serious misconduct. 

Also, courts understand the benefits of limited liability, as it encourages the development of public markets for stocks, thus helping make possible the liquidity and diversification benefits that investors receive from these markets. Because of this, courts generally will require agents of LLCs or corporations to engage in fairly egregious actions in order to justify piercing the corporate veil. This misconduct may include abusing the corporation via intermingling of personal and corporate assets or having undercapitalization at the time of incorporation. 

Business Owners Using Subsidiaries Will Not Get a Free Pass

While different states use different standards to determine whether to pierce the corporate veil and hold a business owner personally liable, courts will generally pierce the corporate veil when the parent company controls and dominates its subsidiary. This happens when the affairs of the parent company and its subsidiary are so intermingled that fairness demands that the acts of the subsidiary be considered as the acts of the parent company. In cases like these, the subsidiary is referred to as an “alter ego” of the parent. Most courts require that there be an element of injustice and unfairness in addition to domination and control to pierce the veil.

The analysis into piercing the corporate veil is very fact intensive and there are a number of factors that courts look at when it comes to determining whether the subsidiary is merely an alter ego of the parent. No single factor is the sole determinative factor. In most cases, it takes a combination of factors being present before a court in order for the court to find that the subsidiary is indeed the parent’s alter ego. 

Factors Used to Determine Whether a Subsidiary Serves as an Alter Ego to a Parent Company

• If the subsidiary was adequately capitalized when formed and solvent enough to pay its anticipated debts when conducting business. Both undercapitalization and insolvency are key factors that indicate an alter-ego relationship.

• Whether the subsidiary had functioning officers and directors. While some overlap of management between the parent and subsidiary are often expected, the test is composed of whether or not the subsidiary’s officers have the power to run the business independently. Particularly, courts look at whether or not the parent makes decisions that ordinarily would’ve been made by the subsidiary. These decisions can include the hiring and firing of employees.

• If the subsidiary observed corporate formalities. Courts will look at whether or not the subsidiary held duly noticed director and shareholder meetings, kept minutes and other books and records, issued stock, had bylaws, etc. Courts will also observe if the subsidiary compiled with the provisions of its governing corporation law – such as filing annual reports, paying franchise taxes, and maintaining a registered agent and registered office.

• If the parent’s assets and subsidiary’s assets were kept separate. The courts will test whether the parent treated the subsidiary’s cash, property and other assets as if they were the parents. Commingling of assets is very frequently cited by courts as evidence of an alter-ego situation.

• Whether the parent held the subsidiary out as being a part of it rather than a separate corporation. The courts consider representations made by the parent about the subsidiary, particularly to the plaintiff, and other factors such as whether they shared the same office address, telephone number, email address and employees. 

Protecting Your Personal Assets

If you’re an entrepreneur, involved in business consulting under your own LLC, or run a small business, make sure to educate yourself on what it takes to pierce the corporate veil in order to protect your personal assets from the potential of accruing business debts and liabilities.