Pierce the Corporate Veil
Pierce the Corporate Veil
by Chris Shlaes
Corporate veil piercing is a legal theory under contract and corporate law which allows courts to disregard the separate existence of a corporation in limited circumstances. When courts order veil piercing, they disregard the separate entity shield enjoyed by corporations, disregarding it as an "illusionary shield." Courts typically do this when a company uses its separate entity status to commit fraud or other illegal acts.
This term was first coined by Professor Arthur Linton Corbin in his treatise, Corbin on Contracts: A Restatement of the Law of Contracts (1962). Corbin introduced this concept into modern American law, and his treatise, containing the concept of corporate veil piercing, is one of the most widely used in the United States.
The first discussion of piercing the corporate veil occurred in 1811 in "Blyth v Birmingham Waterworks Co". In which Lord Eldon said: "I know of no principle which leads to this conclusion more certainly than that on which I have stated it."
In the United States this doctrine has been described as follows:
While there are many examples of courts upholding corporate veil piercing, such as "Abbeville Southern Ry. v. Durham", 288 F. 831 (S.D. AL., 1928), and "Kappel v. International Paper Co.", 306 F. Supp. 471 (E.D. La., 1969), most have been overturned, resulting in a reversal of the law by later courts, such as in "Barnett v. Reardon", 602 F.2d 290 (7th Cir1979). The New Jersey Supreme Court has also indicated that they believe the doctrine is unconstitutional under its current state of development, citing to cases like "Serrator's Devisees v Stodder", 172 N.J Super 616 (1969).
Martin Whyte and his colleagues have argued that the doctrine is not consistent with the legal traditions of other European states. Professor Whyte states, "while we may find it difficult to accept that our domestic judiciaries should be thought capable of developing some novel doctrine, or should even apply it to a variety of factual circumstances differently than other civilized jurisdictions, we are at a loss to understand how less enlightened courts could fail to observe the inconsistency between their decisions on certain facts and inroads on dormant rights."
In "Serrator's Devisees v Stodder", the New Jersey Supreme Court ruled:
The trend has been for the states which have construed this doctrine most broadly to reject it. In "Barnett v. Reardon", the Seventh Circuit Court of Appeals held that courts hold the doctrine unconstitutional only when it is applied "to determine the existence of assets which have been concealed."
Moreover, in "Barnett v. Reardon", it was held that corporate veil piercing can not be used to pierce the corporate veil for insurance fraud and attempted security fraud, but only for actions involving predicate acts such as misrepresentation or concealment.
In contrast to this trend, some states have enacted legislation meant to reduce or eliminate corporate veil piercing as a means of fraud detection. For example, "New Jersey Statutes Annotated Title 9-A", section 1-9:1.30 provides that courts shall not allow corporate veil piercing to be used as a tool of fraud detection for two reasons. First, it is difficult to prove that the existence of a corporate form has been fraudulently concealed. Second, if used in this fashion and applied to all corporations irrespective of whether the corporation has any assets, it would be highly inefficient.
In other words, instead of having courts pierce the veil for every entity which could fit the description of a fraudulent arrangement, legislation exists which allows judges to focus on only those entities which have assets and property concealed within them.
The concept of corporate veil piercing is also alive in Australia. In "Kappel v International Paper Co" the court said the following: "In essence, the sole purpose behind piercing the corporate veil is to enforce an obligation of trust and confidence which does not enter into the contemplation of orthodox contract law." However, in "Riverside Corp. v. Deloitte Touche Tohmatsu", (1998) 165 A.L R. 257 at [47], it was held that a director is under a duty to disclose to his shareholders any information which he knows or ought reasonably to know, leads him reasonably to believe that his company's money was misappropriated by its employees or otherwise unlawfully diverted from its legitimate business purposes. The purpose of the duty of care is to ensure that directors are not dishonestly diverting funds from their companies for their own personal purposes. This duty exists at common law as well as under statutory provisions. In this particular case, the plaintiff did not allege that the directors were diverting business funds to their own personal use, but rather they were diverting the company's money into the defendant's account, which was clearly done in breach of trust.
In the case of "Kemp & Kemp v. Delta Air Lines Inc.", the Court stated that: "The powers and immunities conferred upon a corporation are not self-created but derive from statute, unless they have been granted by common law. If a corporation acts in excess of those powers or immunities, it will be equated with an individual trustee and its affairs or property can be reached in like manner as that of an individual."
In addition to this, the doctrine is applied much less frequently than in other common law jurisdictions. In "Lister v Hesley Hall Ltd", Lord Browne-Wilkinson stated that: "The courts are becoming more reluctant to pierce the corporate veil and for two reasons. In a commercial context, the more ready availability of remedies such as account of profits and an injunction will often suffice to provide an adequate remedy without having to pierce the veil."
In "Devaynes v Noble", Lord Denning created a list of things which should be considered when determining whether or not to pierce the corporate veil. After consulting this list, Lord Denning found that it was appropriate for him to pierce the corporate veil.
Lord Denning considered that if a reasonable man would make a connection between the activities of the company and the individual himself who owned it then is was likely that it would be upheld. In addition, if the activities of the company were unjust or in some way illegal, then it would not be upheld by court.
In "Devaynes", Lord Denning stated:
In that case Lord Denning found that:
Lord Browne-Wilkinson, Lord Diplock, and Lady Hale have all reported from this Court of Appeal decision, which should be read in conjunction with Francis v Woolley and other cases cited above.
Conclusion:
The law is that:
In the case of "Marek v. Lernout & Hauspie Groningen BV" the Supreme Court of Norway ruled that the individual shareholder is not entitled to claim repayment of her contribution to a company she did not participate in managing. The Supreme Court pointed out that if a contributing shareholder does not take part in the management of a company, no interest can be created in him to the profits thereof or claims against them.