Piercing The Corporate Veil: An Avoidable Pitfall
New York courts will disregard or "pierce" the corporate veil, the statutorily protected liability shield that is the keystone of the corporate form, when that shield is abused by business owners for their own gain. Business owners, if faced with such a directive, become personally liable for the acts and debts of the entity.
To pierce the corporate veil, New York courts require plaintiffs to prove that:
- A business owner (or in the case of a parent/subsidiary, the parent) exerted such a level of dominance over the entity so as to make it the owner's instrumentality for the owner’s personal use; and
- That corresponding harm was caused to the plaintiff.
In cases where this standard has been met, courts have disregarded the separate identities of entity and owner, essentially deeming them alter egos under settled notions of equity. Courts have even gone so far under the veil-piercing doctrine as to pierce it in both directions, not only making the owner liable for the acts and debts of the entity, but vice versa.
New York courts evaluate corporate veil matters on a case-by-case basis, but various factors are typically relied upon to establish the existence of an alter ego, among them:
- Inadequate capitalization of an entity;
- Absence of corporate governance formalities;
- Movement of funds between personal and business bank accounts;
- Payment of debts of the dominated entity by its parent;
- Sharing of office space and telephone numbers by affiliated entities and their owners; and
- Absence of arms-length relationships between affiliated entities.
Business owners should be mindful of these dangers and employ internal checks and balances to avoid them. Suggested best practices for responsible oversight include:
- Comply with corporate formalities;
- Maintain accurate and up-to-date corporate records;
- Elect officers and directors;
- Properly capitalize and adequately insure subsidiaries;
- Ensure that each subsidiary holds assets required for its operations;
- Conduct transactions with subsidiaries on an arms-length basis;
- Allow subsidiaries to hire their own employees; and
- Do not refer to subsidiaries as “divisions” or “departments” of the parent company.
Adhering to these best practices will support the proveable separation of an entity from its ownership, allowing that relationship to serve the purpose for which it has been established.
This publication is intended as an information source for clients, prospective clients, and colleagues and constitutes attorney advertising. The content should not be considered legal advice and readers should not act upon information in this publication without individualized professional counsel.