Limited Liability and Piercing the Corporate Veil

• Pages: 69-94
• Author: Stephen M. Bainbridge

69

Chapter 4

LIMITED LIABILITY AND PIERCING

THE CORPORATE VEIL

§ 4.1 Introduction

Limited liability means that shareholders of a corporation are

not personally liable for debts incurred or torts committed by the

firm. If the firm fails, shareholders’ losses thus are limited to the

amount the shareholders invested in the firm—i.e., the amount the

shareholders initially paid to purchase their stock.

MBCA § 6.22(b) offers a typical statutory formulation of the

doctrine: “Unless otherwise provided in the articles of incorporation,

a shareholder of a corporation is not personally liable for the acts or

debts of the corporation except that he may become personally liable

by reason of his own acts or conduct.” Notice that § 6.22(b) contains

two provisos. First, the articles of incorporation may provide for

personal liability. This is nothing more than an example of the

familiar principle that most corporate law rules are default rules—

i.e., off-the-rack principles that may be modified by contract. Second,

personal “liability may be assumed voluntarily or otherwise.”

1

A

shareholder, for example, voluntarily may assume liability through a

personal guaranty. A guaranty is a contract by which the guarantor

is bound to perform in the event of a breach of contract by the party

whose performance is guaranteed. Contract creditors of close

corporations often require controlling shareholders to personally

guarantee the firm’s debts.

Alternatively, personal liability may be involuntarily thrust

upon a shareholder under the equitable remedy known as “piercing

the corporate veil.”

2

Limited liability entails negative externalities—

1

MBCA § 6.22 cmt.

2

There is substantial disagreement in the literature as to whether veil

piercing is a n equitable remedy. The principal significance of the issue, of course, is

that equitable remedies need not be tried before a jury but parties subject to legal

remedies generally are entitled to trial by jury. Compare International Fin. Serv. Corp.

v. Chromas Tech. Canada, Inc., 356 F.3d 731 (7th Cir.2004) (veil piercin g is equitable

remedy and affords no right to jury trial); Schultz v. General Elec. He althcare

Financial Services Inc., 360 S.W.3d 171 (Ky.2012) (holding “that the doctrine of

piercing the corporate veil arises in equity”) with Bower v. Bunker Hill Co ., 675

F.Supp. 1254, 1261–62 (E.D.Wash.1986) (veil piercing is a legal remedy because it

seeks a money judgment and thus a right to jury trial exists). See also Wm.

Passalacqua Builders, Inc. v. Resnick Developers South, Inc., 933 F.2d 131 (2d

Cir.1991) (holding that “it was entirely proper for the district court to submit the

corporate disregard issue to the jury” because, inter alia, whether the corporate form

should be pierced “is the sort of determination usually made by a jury because it is so

70

LIMITED LIABILITY AND PIERCING

THE CORPORATE VEIL

Ch. 4

it allows shareholders to externalize part of the costs of their

investment onto other corporate constituencies and, in a sense, to

society at large. In appropriate cases, the veil piercing rules allow

those injured by the corporation to force the corporation’s

shareholders to internalize the harm committed by the firm. As a

seminal 1912 law review article put it, “When the conception of

corporate entity is employed to defraud creditors, to evade an existing

obligation, to circumvent a statute, to achieve or perpetuate

monopoly, or to protect knavery or crime, the courts will draw aside

the web [i.e., veil] of entity, will regard the corporate company as an

association of live, up-and-doing, men and women shareholders, and

will do justice between real persons.”

3

Obviously, veil piercing is where much of the action is for

lawyers. From a litigation standpoint, veil piercing allows creditors

to satisfy their claims out of the personal assets of shareholders.

From a transactional planning perspective, the risk of veil piercing

requires lawyers to exercise some care in forming the corporation and

advising the client as to its conduct.

Having said that, it is critical to stress that veil piercing is the

exception, not the rule. The law permits incorporation of a business

for the very purpose of avoiding personal liability.

4

The equitable

exception obviously could easily swallow the legal rule unless courts

are careful to permit veil piercing only in certain egregious cases.

Accordingly, many decisions in this area state that courts will pierce

the veil only reluctantly.

5

fact specific”); American Protein Corp. v. AB Volvo, 844 F.2d 56, 59 (2d Cir.1988) (veil

piercing is an equitable remedy but issue is normally submitted to a jury).

3

I. Maurice Wormser, Piercing the Veil of Corporate Entity, 12 Colum. L. Rev.

496, 517 (1912). Shareholders may also face personal liability in connection with

watered stock or unlawful dividends. In some states, special statutory provisions

impose personal liability on shareholders with respect to certain corporate debts. New

York and Wisconsin, for example, do so with respect to employee wages. See, e.g., N.Y.

Bus. Corp. L. § 630.

4

“Because society recognizes the benefits of allowing persons and

organizations to limit their business risks through incorporation, sound public p olicy

dictates that imposition of alter ego liability be approached with caution.” Las Palmas

Associates v. Las Palmas Center Associates, 235 Cal.App.3d 1220, 1249 (1991). The

Las Palmas court approvingly cited Cascade Energy & Metals Corp. v. Banks, 896 F.2d

1557, 1576 (10th Cir.1990), in which the 9th Circuit held (applying Utah law) that

“corporate veils exist for a reason and should be pierced only re luctantly and

cautiously. The law permits the incorporation of businesses for the very purpose of

isolating liabilities among separate entities.” See also Bartle v. Home Owners Co-op.,

127 N.E.2d 832, 833 (N.Y.1955) (“The law permits the incorporation of a business for

the very purpose of escaping personal liability”).

5

See, e.g., Cascade Energy & Metals Corp. v. Banks, 896 F.2d 1557, 1576

(10th Cir.), cert. denied sub nom. Weston v. Banks, 498 U.S. 849 (1990); McCulloch

Gas Transmission Co. v. Kansas-Nebraska Natural Gas Co., 768 F.2d 1199, 1200 (10th

Cir.1985); DeWitt Truck Brokers v. W. Ray Flemming Fruit Co ., 540 F.2d 681, 683