Managing Risks of Veil Piercing Liability

Legal personhood of corporate entities is a fundamental tenet of doing business. Legal personhood is also critical to allowing businesses and investors to manage risks. However, corporate families may not have the protection of their “corporate veil” and expose themselves to “veil-piercing” claims when the corporate form is abused.Because many corporations, limited partnerships, and limited liability companies are organized under Delaware law, this article provides a general overview of the standard of veil piercing under an “alter ego” theory under Delaware law where the corporate form is sought to be disregarded. In addition, it provides some practical steps that can be implemented to manage the risk of a veil piercing claim.

As a starting point, Delaware courts by default will respect the corporate form, and persuading a Delaware court to disregard the corporate entity is a high bar. Circumstances under which a Delaware court has allowed a veil piercing claim to proceed past a motion to dismiss tend to be cases where substantial and detailed factual allegations reflect that there was fraud, public wrong, contravention of law or contract, or where equitable consideration requires it.

Delaware courts consider a number of factors in determining whether to disregard the corporate form and pierce the corporate veil, including whether the company was adequately capitalized; whether the company was solvent; whether corporate formalities were observed; whether the dominant shareholder siphoned company funds; whether, in general the company simply functioned as a façade for the dominant shareholder. While no single factor is determinative, some combination of these factors is required. In addition, Delaware requires that the corporate structure causes an overall element of injustice or unfairness.

In the last few years, Delaware cases that involved a veil piercing claim reflect the standard to pierce corporate veil remains high. Those cases that survived a motion to dismiss contained allegations that were highly fact specific and demonstrated that the corporate form was used to commit fraud, and in particular, to avoid a financial liability.

While the bar to plead a pierce the corporate veil claim is high, and the ultimate burden of establishing liability is highly fact specific, businesses can implement several ways to preserve corporate separateness.

• Minimize overlapping high-level personnel managing, operating, and controlling a subsidiary’s or affiliate’s day-to-day operations. This does not necessarily mean a parent cannot set general policies or standards of operation or must avoid any involvement in a subsidiary’s or an affiliate’s operations. Courts examine the level of hands-on and day-to-day control. Even if the same people were involved, related companies may still operate independently by focusing on different markets, products, or services.
• Adequately capitalize a subsidiary or an affiliate, particularly at formation, and maintain its solvency.
• Maintain corporate formalities, such as separate email addresses, letterhead, names, employees, locations, bank accounts, logos, and books and records.
• To the extent that there are intercompany transactions, which are not improper in and of themselves, ensure proper accounting of all funds and proper documentation of such transactions.
• Changes in corporate structure or form, meetings and minutes, and votes should be documented.

Veil piercing is a highly fact-intensive claim and requires an element of fraud or injustice under Delaware law. No single factor alone is likely to justify veil piercing. A company can better manage its risk of a veil piercing liability by implementing standards and practices that provide evidence of its independence from a parent company or dominant shareholder.