1st Dec 2017

Piercing the corporate veil                                                                                                                                                                                                                                                                                                                                                                                                                                                    

People form business entities to protect their personal assets. They do not want to be personally liable for their business’s 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 seized to satisfy the owners’ personal debts. This is known as reverse veil 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. They often rule 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.

Personal liability may be imposed even if corporate formalities are observed                                                                                                                                                                                                                                        

Even when all legal formalities have been observed in forming a business its legal status may still be disregarded and personal liability imposed on its owner. This can happen when owners try to game the system by arranging assets in such a manner as to disclaim that they are business assets at all. That is to say, assets are not invested capital, but rather, loaned capital – from the owners. This is often 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 undercapitalized, another basis for piercing the veil.[6]

Business creditors may also claw back and seize money already taken out of a business by its owners. Taking money out of a business as a distribution may be 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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