Insights: Article

Piercing the Corporate Veil & Individual Liability

By Lela Lawless

November 11, 2016

Corporations are primarily formed to insulate the shareholder -- an individual, partnership or another corporation -- from liability. Corporations and their counterparts, Subchapter S corporations and limited liability companies, are legal entities with distinct legal rights and liabilities separate from their shareholders. Individual shareholders normally have no liability for the debts and actions of the corporation simply by owning an equity interest. However, when the facts warrant, courts will disregard the separate legal existence of a corporation and pierce the corporate veil to hold individual shareholders liable for the conduct and debts of the entity.

The ultimate issue for the courts to decide is whether the corporation is essentially a shell or a facade for the operations of a sole or dominant shareholder. Courts consider numerous factors when determining if the corporate entity should be disregarded. These factors or indicia may include:

  • Failure to adequately capitalize the corporation
  • Commingling of personal and corporate funds and other assets
  • Failure to observe corporate formalities with meeting minutes, corporate by-laws and officer elections
  • Loans to or from the corporation without sufficient consideration
  • Use of the same office or business location
  • Use of common employees, vendors and processes
  • Diversion of corporate assets to a shareholder or entity
  • Domination and control of the corporation by shareholders
  • Use of the corporation to procure contracts, services or labor
  • Failure to maintain arm's length transactions
  • Generally treating the assets of the corporation as the assets of the shareholder

The elements listed above are subject to intense scrutiny by the courts. Thus, being able to fully understand and properly assess relevant indicia of alter ego is imperative for all parties involved in an alter ego dispute. Assistance from a forensic accountant in litigation can be invaluable. Forensic accountants analyze, interpret, summarize and present complex financial and business related issues in a manner which is both understandable and properly supported.

Forensic Accountants Offer Invaluable Expertise
Procedures performed by forensic accountants may include review of initial corporate records, shareholder certificates, balance sheets, income statements, cash flow statements, cancelled checks and transfers to determine whether funds were actually invested and assets exist. A forensic accountant could prepare an analysis of written loan agreements to determine principal and interest amounts and the right to enforce payment. Bank accounts are examined to determine if corporate accounts are maintained separately and distinctly from personal accounts and related parties, and if personal shareholder expenses are paid by the corporation.

A forensic accountant will also analyze credit card statements, expense reports, check registers, general ledger expense detail and other financial documents for unauthorized payments or diversion of funds. An analysis of contracts and agreements may also be performed to assess whether they reflect transactions at fair market value. 

Forensic accountants retained at an early stage in the litigation process are vital to the success of any attempt to pierce the corporate veil. Forensic accountants use their knowledge and experience to efficiently identify and investigate factual evidence and to assess the relevant issues and relationships that support or refute the existence of an alter ego.

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