1st Dec 2017

Piercing the corporate veil                                                                                                                                                                                                                                                                                                                                                                                                                                                    

People form business entities to protect their personal assets. They want to avoid personal liability for business debts. However, a business owner’s personal assets can sometimes be seized to pay business debts. This happens when a court reviews “the entire spectrum of relevant facts” and is satisfied that a corporation or other business entity form (purporting to limit owners’ personal liability) should be “disregarded,” and its owners held personally liable.[1] When courts do this they are said to have pierced the corporate veil, an expression whose imagery suggests a veil of armor shielding personal assets being pierced by a sword. Courts may disregard the legal separateness of individuals and businesses in the interests of justice. It’s part of their equitable function. They may even, for example, order business assets to be used to satisfy personal debts. This would be a variation of what’s known as reverse piercing.[2]

In Michigan, “there is no single rule delineating when the corporate entity may be disregarded” and an owner held liable.[3] It depends on the case. But there are some guiding principles.

Fraud is a key reason for disregarding a business entity form. Michigan courts will not allow the State’s laws to be used to work a fraud on innocent third parties, often noting that business entities should not be abused or “used to subvert justice.” But fraud is not the only reason for disregarding a business entity. “The corporate veil can be pierced in the absence of fraud” in Michigan.[4] The reasons for doing so, however, are not well defined and courts seem to struggle to provide meaningful guidance as to what will trigger such a result. There’s a circularity to their reasoning. How exactly does a business owner abuse the entity form and subvert justice, after all? One court distilled its reasoning:

[I]t comes down to a question of good faith and honesty in the use of the corporate privilege for legitimate ends. If a corporation is owned and controlled by another and is manipulated by the owner for its own purposes and in its own interests to the prejudice of innocent third parties, or the public welfare, it may be necessary to limit such abuse of the corporate capacity or shield. [5]

In deciding such matters courts look at everything, the entire spectrum of facts. They look at whether the business was created and maintained properly, according to statutory and common law requirements. In other words, were corporate formalities observed? Are the articles, bylaws, and books in order, were annual meetings held, etc.? A court may conclude that everything was done right – resulting in a finding of what’s called a de jure entity. Or, it may conclude that things weren’t done right but a good faith attempt was made – resulting in what’s called a de facto entity. Both types of entities are given some recognition and regard in the court’s analysis. Or, it may conclude that a wholly defective attempt to form an entity was made – resulting in a finding of no cognizable existence at all.

Liability though corporate formalities observed                                                                                                                                                                                                                                        

But even when all corporate formalities are observed and done right, a business may still be disregarded and personal liability imposed. Sometimes owners try to game the system by taking liberties in arranging assets, doing so in a manner by which all or most of an entity’s apparent assets are not really its assets at all. That is, the assets may not be invested capital, but rather, loaned capital – from the owners. This may be done so that if money gets tight and business creditors come knocking, the owners are poised to step to the front of the line to call their loans, and take back what is “theirs.” When disputes follow they protest, “How can a business creditor claim a right to my assets?” In such cases the loan-to-capital ratio may be unfair and the business deemed to be undercapitalized, another basis for seizing personal assets to pay business debts.[6]

Business creditors may also “claw back” and seize money already taken out of a business by its owners. Taking money as a distribution of profits is unlawful if it renders the business unable to pay its bills. Michigan corporation law requires business owners to make “adequate provision” for creditors before taking such distributions.[7] Courts look at everything. The right to shield one’s assets through the corporation or limited liability company form is a privilege – but what the law giveth, it may taketh away.

 

(* Del A. Szura is a member of Szura & Delonis, PLC. This post is intended for general information and educational purposes and should not be construed as legal advice. All Rights Reserved. Copyright 2017.)

[1] Klager v. Robert Meyer Co, 415 Mich. 402, 411-412 (1982).

[2] See generally, Wells v. Firestone Tire and Rubber Co., 421 Mich. 641 (1985).

[3] Foodland Distribs. v. Al-Naimi, 220 Mich. App. 453, 456-7 (1996).

[4] Id. at 460.

[5] Id.

[6] Acton Plumbing & Heating v. Jared Builders, Inc., 368 Mich. 626 (1962).

[7] Mich. Comp. Laws §§450.1855(a), 450.2855(1)(a); or “reasonable provision” for limited liability companies, Mich. Comp. Laws §450.4808(1)(a).

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