CHAPTER § 6.02 Piercing the Corporate Veil

• Jurisdiction: United States

§ 6.02 Piercing the Corporate Veil

A corporation is a legal fiction, an "artificial being, invisible, intangible, and existing only in contemplation of law."² Absent some form of abuse of the corporate form, courts will generally treat a corporation and its affiliates as separate and distinct entities and thereby respect the "corporate veil" that separates them. With respect to the relationship between a parent corporation and its subsidiary, sometimes the separate incorporations are disregarded, and the subsidiary is deemed a mere instrumentality or alter ego of the parent.³ In these cases, most often characterized by excessive and improper control by a parent over its subsidiary, courts will allow a plaintiff to "pierce the corporate veil" and hold the parent corporation liable for the torts of its subsidiary. On the other hand, courts will decline to pierce the veil where corporate formalities are respected, the parent does not improperly control the subsidiary, the subsidiary is adequately capitalized, and there is no showing of fraud or inequitable conduct.⁴

[1] Factors Generally Considered in Corporate Veil-Piercing Cases

Most states employ at least a two-prong test for determining whether the corporate veil should be pierced. Specifically, they look at (1) whether there is complete domination by the parent over the subsidiary with respect to the transaction, and (2) whether such domination was used to commit a fraud or wrong that resulted in injury.⁵ Where a subsidiary is merely the alter ego or instrumentality of its parent (such that the parent and subsidiary operate as a single entity), the corporate veil may be pierced, destroying the separate identities of the parent and subsidiary and rendering each entity derivatively responsible for the liabilities of the other.⁶ In at least some jurisdictions, the plaintiff's burden of proof on a veil-piercing claim is higher than the typical preponderance of the evidence standard.⁷ Although the question has not been addressed in all jurisdictions, the same test applied to piercing the veil of corporations is generally applied to that of limited liability companies and other business forms.⁸

When piercing the corporate veil, courts have traditionally applied the law of the state of incorporation of the parent.⁹ However, if the claim implicates the interests of the forum, many courts apply lex fori (i.e., the law of the jurisdiction in which a legal action is brought).¹⁰ Under New York's choice-of-law principles, for example, the law of the state of the subsidiary's incorporation usually governs the piercing analysis.¹¹ Delaware courts, on the other hand, appear to apply Delaware law when either a Delaware parent or subsidiary is involved.¹² In other states, choice of law for veil-piercing cases is unsettled or inconsistent.¹³ Due to the lack of practical uniformity regarding which state's veil-piercing law will apply to a given claim, "investors and their counsel are best served by a working assumption that their corporate veil may be judged by the standards of any jurisdiction in which personal jurisdiction may properly be asserted over the corporation and its shareholders."¹⁴

[a] Domination and Control/Alter Ego

Courts consider a number of factors in assessing whether parent and subsidiary corporate identities should be disregarded, e.g., whether the subsidiary is the mere alter ego of the parent. Most courts discuss this issue in terms of the parent's control over the subsidiary, and, typically, total control or domination over the subsidiary is required.¹⁵ Many piercing factors, standing alone, do not indicate improper control; only when those factors reach a critical mass do courts conclude the subsidiary is the alter ego of the parent and pierce the corporate veil.¹⁶ Furthermore, in order to warrant veil piercing, the manifestation of the control relationship between parent and subsidiary should be closely connected to the cause of action alleged.¹⁷

Factors bearing on improper control include whether:

(1) a subsidiary is inadequately capitalized for its corporate undertaking;
(2) the parent finances the subsidiary;
(3) the parent owns all or most of the stock in the subsidiary;
(4) the parent pays salaries and other expenses or losses of the subsidiary;
(5) the subsidiary is insolvent;
(6) the subsidiary has no business except with the parent;
(7) the subsidiary pays excessive dividends to the parent;
(8) records are improperly kept;
(9) the parent and subsidiary share common officers and directors;
(10) officers and directors function in dereliction of their fiduciary duties; for example, directors of the subsidiary do not act independently in the interest of the subsidiary, but take their orders from the parent in the latter's interest;
(11) corporate formalities are not observed (e.g., keeping separate books and records and holding board and/or shareholder meetings);
(12) the parent siphoned corporate funds from the subsidiary;
(13) the subsidiary functions as a façade for the parent (e.g., the subsidiary is described in the papers of the parent or in statements of its officers as a department or subdivision of the parent, or business or financial responsibility is referred to as the parent's);
(14) the parent uses the property of the subsidiary as its own;

¹⁷ See Ethypharm S.A. Fr. v. Bentley Pharm., Inc., 388 F. Supp.2d 426, 432 (D. Del. 2005) (pharmaceutical business-tort claims) ("In order for the parent corporation to be liable under this test, there must be a close connection between the relationship of the corporations and the cause of action.") (quotation omitted); Garza v. Citigroup Inc., 192 F. Supp.3d 508, 514 (D. Del. 2016) (quoting Ethypharm S.A. Fr.); C.R. Bard, Inc. v. Guidant Corp., 997 F. Supp. 556, 560 (D. Del. 1998) (medical-device patent-infringement claims) (same).

(15) the parent's employees directly manage or oversee certain aspects of the subsidiary's operations;
(16) inadequate insurance is maintained for the subsidiary;
(17) the parent and subsidiary prepare consolidated financial statements and tax returns; and
(18) the parent and subsidiary share common business departments.¹⁸

The question of adequate capitalization of the subsidiary is particularly important in tort cases "because tort claimants usually have not voluntarily dealt with the subsidiary, and the question is whether a parent should be able to transfer a risk of loss or injury to members of the general public in the name of a subsidiary that may be marginally financed."¹⁹

In the context of determining whether a court may exercise personal jurisdiction over a non-resident or foreign parent corporation based on its subsidiary's contacts with the forum, several jurisdictions apply veil-piercing principles under either a vicarious "alter-ego" test and/or a direct "agency" test.²⁰ The "alter-ego" test for personal jurisdiction resembles the standard test to pierce the corporate veil for purposes of imposing liability (i.e., control plus fraud or injustice), while the "agency" test is based on common-law principal-agent rules and focuses more on the parent's control over the subsidiary, using many of the same factors that are utilized for the control prong of the veil-piercing analysis.²¹ Nevertheless, some courts conflate the alter-ego and agency tests for determining personal jurisdiction.²²

[b] Fraud or Injustice

In addition to the alter-ego control rule, many jurisdictions require a showing of fraud or injustice that results in injury to the plaintiff.²³ Where this additional element is required, there is no clear, universally applied definition of "fraud" as used in the veilpiercing analysis. Often, "fraud" is used interchangeably with terms like "injustice" or "wrong."²⁴ For example, it appears in Delaware (and the Third Circuit) that actual fraud or sham on the part of the parent corporation is not required where there is "something that is similar in nature to fraud or a sham."²⁵ Nevertheless, "the fraud or injustice . . . must, in particular, be found in the defendants' use of the corporate form," as opposed to some unrelated or general fraudulent, unjust, or unfair conduct.²⁶ Furthermore, as the justification for piercing the corporate veil is "to prevent, fraud, illegality, or injustice, or the adverse effects thereof," some jurisdictions, including Delaware, view such "fraud or similar injustice relative to the use of the corporate form as immaterial . . . if such fraud or injustice has already been remedied."²⁷

Generally, fraud is an important piercing component in contract cases because the plaintiff has voluntarily contracted with a subsidiary in reliance on its status as a standalone corporation.²⁸ When the subsidiary turns out to be nothing more than an instrumentality of the parent, plaintiffs argue that a fraud has been committed because the plaintiff relied on the false representation that the subsidiary was a distinct entity. Alternatively, where the parent and subsidiary appear to operate as a single entity (or at least in close coordination), a plaintiff may contract with the subsidiary with the expectation that the parent will bear ultimate responsibility for the subsidiary's obligations—or even with the belief that the plaintiff was dealing with the parent all along. In such circumstances, where the plaintiff's belief was reasonable, a parent's attempt to avoid its subsidiary's liabilities can work a fraud or injustice.²⁹

In tort cases, on the other hand, some jurisdictions specifically do not require proof of fraud when piercing the corporate veil, and instead focus on whether the subsidiary was and is adequately capitalized.³⁰ The basic rationale is that tort plaintiffs, who deal with their tortfeasors involuntarily, should not have to bear the risk that the tortfeasor might be improperly under-capitalized by a parent corporation, whereas other plaintiffs who deal voluntarily or contractually with a subsidiary are presumably able to learn...