Owner Liability – Piercing the Veil

Tuesday, 30 October 2018 15:07 Written by  Bill MacMinn

A corporation or limited liability company provides multiple advantages to business owners which is why business lawyers so frequently recommend their use. Among the most significant of these advantages is limited liability, a concept grounded in the fact that the entity has a separate legal existence from its owners and therefore its obligations are not those of its shareholders or members. Of course an owner may voluntarily agree to be responsible for such obligations as, for example, would be the case if he or she guarantees the entity’s bank borrowing. The shield of limited liability is not, however absolute. It can be breached rendering owners financially responsible for the entity’s obligations. In Pennsylvania, as in most states, there is a strong presumption against ignoring the distinction between the entity and its owners. However certain conduct by business owners will result in the court’s “piercing the veil” – ignoring the distinction between the corporation or limited liability company and its owners. Generally, courts will pierce the veil when those in control of the entity use that control, or use the entity’s assets, to further his, her or their own personal interests. While there is no single test to determine when the piercing of the veil is appropriate courts look to many factors.

These include:

1. Is the entity undercapitalized?

2. Did the owners fail to adhere to requisite formalities such as holding shareholder and directors meetings and keeping appropriate records?

3. Was the entity insolvent at the relevant time?

4. In the case of a corporation were dividends paid or were corporate funds siphoned into the pockets of the controlling shareholders?

5. Was there a functional board of directors and corporate officers managing the affairs of the entity?

6. Was there substantial intermingling of the financial affairs of the entity and its owner(s)? 7. Under the circumstances, was the entity form used to perpetrate a fraud? Generally, the court will pierce the corporate veil when a review of these factors shows that the form is a sham, constituting a facade for the operations of the dominant shareholder or member making the entity effectively the “alter ego” of the individual(s).

Courts also ignore the form where necessary to prevent fraud, illegality, injustice, or a contravention of public policy. Business owners may be forced to shoulder the liabilities of their entity in other situations as well.

Some of these are:

1. Individual liability under the Fair Labor Standards Act, the Pennsylvania Human Relations Act, ERISA and the Wage Payment and Collection Law. Under certain situations, these statutes impose liability on corporate officers and LLC members for the entity’s violation of their terms and may impose the financial obligation of the entity upon the owners. For example, the Wage Payment and Collection Law makes corporate officers personally responsible for violations of the act, including payment of wages found to be due.

2. Trustee Ex Maleficio Virtually all entities that have employees collect state or federal income taxes in the form of wages withheld from employees’ paychecks. Some entities also collect sales taxes. Withheld income taxes and sales taxes are held in trust for the relevant taxing authority and are to be remitted to that taxing authority on a timely basis. Those responsible for the performance of this duty are personally responsible if the entity fails to do so. Courts employ a multi-factorial test to identify the responsible individuals, but the general concept is that an employee or officer who has the power to direct payment of the entity’s funds can be held personally responsible to pay if the entity fails to remit withheld sales or income taxes to the relevant taxing authority.

3. Duties in Insolvency Most all corporate directors know that they owe two core duties to the corporation and its shareholders – a duty of care and a duty of loyalty. The duty of care requires a director to use the same degree of care that an ordinarily careful and prudent person uses in similar circumstances. It requires that directors reasonably inform themselves, before making a decision, of all relevant information and alternatives. The duty of loyalty requires the directors to act in good faith for the benefit of the corporation and its stockholders. What is not as well known is that when the entity is insolvent, those duties are no longer owed only to the shareholders. Instead the shareholders’ interests become subordinate to those of the entity’s creditors. Failure to faithfully discharge these duties now renders the directors personally liable to the entity’s creditors.

4. Voidable Transfers A creature of statute, a voidable transfer can be one of two types: a transfer made with actual intent to hinder, delay or defraud a creditor of the entity; or, a transfer made without receiving reasonably equivalent value in exchange at a time when the entity is insolvent. Declaring a transfer voidable results in the asset transferred being “clawed back” into the hands of the entity. The risk is born by the transferee of the asset in question – often an owner of the entity.

The shield of limited liability is a valuable feature of the corporate and limited liability company form as it protects the owners of the entity from liability for its obligations, effectively limiting that liability to the owner’s investment in the entity. However that shield can be lost where owners deliberately or unwittingly conduct the business of the entity in an unlawful manner. Business owners are well advised to take care to manage their entity so as to maintain the limited liability shield.  The corporate and litigation departments of Antheil Maslow & MacMinn, LLP can provide valuable counsel to business owners facing these questions and, if necessary, provide effective legal representation in litigation of these claims.

Last modified on Wednesday, 07 November 2018 21:18
Bill MacMinn

Bill MacMinn

Bill concentrates his practice in the area of litigation, including Commercial Litigation, Personal Injury, Products Liability, Employment Litigation, Estate Litigation, Real Estate, and Arbitration. He represents a broad spectrum of individuals, corporations and institutions in commercial, employment litigation, collection, construction and personal injury actions. He has expertise in a wide variety of venues in Bucks and surrounding counties, and in the United States District Court. Bill also has extensive experience in Alternate Dispute Resolution forums, including participation in the American Arbitration Association, private arbitrations and private court systems. He is frequently appointed as arbitrator.

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