Piercing the Corporate Veil - Does Incorporation Provide Protection?
Brenda H. Collier

Brenda H. Collier has been a business lawyer and a litigator for over sixteen years and her diverse clientele includes start-up companies, small businesses and Fortune 100 companies. Ms. Collier has extensive courtroom experience and is equally at ease in the boardroom negotiating deals for clients.   Ms. Collier is a 1982 graduate of the University of Texas law school and a University of Tulsa, Oklahoma undergraduate.

As most owners of corporations are aware, the rights and liabilities of a corporation are separate and distinct from those of its shareholders. The corporation is said to be like a veil that shields its shareholders from corporate debts and other similar obligations.

For instance, if a judgment is entered against a corporation, its shareholders will be liable for the judgment only to the extent of their investment in the corporation; the shareholders' personal assets will not be subject to liability. The general rule is that the corporate entity protects the shareholders from liability beyond their investments. The situation changes, however, in a scenario in which the corporation is being used to defraud creditors or to achieve injustice. In those cases, Texas courts have "pierced", or set aside, the corporate veil and held the shareholders personally liable for the corporate debts and other obligations.

The fact that a corporation has only a few or just one shareholder does not necessarily mean that its entity status will be disregarded and its corporate veil pierced. So long as the corporation is adequately financed, complies with all formation and recordkeeping requirements and has a legal purpose and objective, its shareholders will enjoy the protection of limited liability.

By far, the largest number of cases in which the courts have pierced the corporate veil have been brought under two theories, (1) alter ego, or (2) sham to perpetuate a fraud:

ALTER EGO: When a corporation is not operating as a true legal entity and is being used by its shareholders as a "shell" to control private interests and assets or debts, the corporation is said to be the "alter ego" of its shareholders.

A corporation may appear to be the alter ego of its shareholders when no corporate stock is issued following formation of the corporation, no directors are elected, no corporate records are kept, or personal funds or assets of shareholders are co-mingled with those of the corporation (e.g. no separate bank accounts) and records are maintained by the shareholders.

The Texas Supreme Court has held that alter ego is shown from the total dealings of the corporation and the individual, including the degree to which corporate formalities have been followed and corporate and individual property have been kept separate, the amount of financial interest, ownership and control the individual maintains over the corporation and whether the corporation has been used for personal purposes.

If the shareholders have themselves disregarded the corporate form, the law will also disregard it and not offer the shareholders the protection that the corporate structure gives its owners.

SHAM TO PERPETUATE A FRAUD: Texas courts have also pierced the corporate veil where a failure to do so would result in fraud or other injustice. For example, suppose that a corporation is being used to defraud creditors: the shareholders invest little money in the corporation and the corporation incurs debts far in excess of the investments, with little hope of being able to pay them.

In that case, a failure to pierce the corporate veil and hold the shareholders personally liable would be an injustice to the creditors. A sham to perpetuate a fraud exists where a shareholder has used, abused or manipulated the corporate form of the corporation to the detriment of a third party. This typically occurs when the shareholder or an affiliated corporation drains funds from the corporation, which results in the corporation being unable to pay its creditors.

An example of a sham to perpetuate a fraud is where a corporation owes obligations it does not want to pay: the shareholders drain off corporate revenues, sells most of the corporate assets and a new business then starts up that is basically a continuation of the old business with many of the same shareholders, officers and directors. The "old" corporation's creditors are left "holding the bag" and the "new" corporation is free of debt.

To avoid liability, a shareholder who is involved in the business operations of the corporation should stay aware of the financial condition of the corporation, the corporation's formation and recordkeeping requirements, ensure that business is conducted on a corporate and not a personal basis, and ensure that the corporation has and keeps a legal purpose and objective.

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