The phrase, “piercing the corporate veil,” is not a bankruptcy concept and does not appear in the Bankruptcy Code. Rather, it is a state-law equitable remedy for collapsing corporate entities with their principal shareholders to enable plaintiffs in civil actions to recover money from them—usually in fraud cases. Typically, the creditors sue the business entities and their owners in state court first and ask the court to pierce the corporations’ veils. After that, either the corporation or the owners file bankruptcy. The state-court case is removed to the bankruptcy court, which applies state law to the piercing issue. If the creditors win, they will usually move the bankruptcy court to hold the debts owed by the debtor-owners as nondischargeable.
The problem with piercing the corporate veil, though, is that corporation laws are deliberately designed to allow entrepreneurs to form business entities for precisely the reasons creditors in these circumstances argue against: limiting their personal liability for debts their business entities take on. As a result, actions to pierce the corporate veil are both contentious and can be legally confusing.
To paraphrase New York’s rules for piercing the corporate veil, a plaintiff must prove that the company’s owners completely “dominated” the corporate entity to wrong the plaintiff. A plaintiff can prove the owners’ “domination” by showing that a totality of the following factors is present.
(1) Absence of corporate formalities
(2) Inadequate capitalization
(3) Use of corporate funds for shareholders’ uses
(4) Overlap in ownership and corporate officers
(5) Common locations for corporate entities, e.g. two companies using the same offices and telephone numbers
(6) The amount of business discretion displayed by the corporation
(7) The extent to which the dominated corporation engages in arm’s length transactions with related corporations
(8) Whether the corporations are treated as independent profit centers
(9) Guarantee or payment of debts by the dominated corporation by related corporations
(10) Use of the dominated corporation’s property by related corporations
Again, the level of detail in these factors is due to the fact that corporate entities are supposed to shield their shareholders from liability. Naturally, creditors must also prove that the owners intended to wrong them.
Most business bankruptcy debtors do not need to worry about attempts to pierce their corporate veils because they usually file bankruptcy for honest reasons—business has slowed to make it impossible for them to repay their debts. Moreover, the Bankruptcy Code gives creditors and trustees other options for retrieving assets that a corporation transfers to its shareholders, namely, avoiding preferences. Finally, when owners file bankruptcy along with their businesses, as is often the case, there is no veil to pierce.
One recent New York bankruptcy case in which a corporation’s veil was pierced is In re: Stewart Adler, No. 8-04-84807-reg (pdf). The debtor owned five corporations that he abused to defraud another businessperson, Lisa Ng. When the companies defaulted on their debts to her, she sued them in New York Supreme Court, but their owner, Adler, filed chapter 7 bankruptcy, which led to the state-court case being severed. Ng won a judgment against the corporations in state court, but eventually the bankruptcy court had to decide whether to pierce Adler’s companies’ veils to hold him personally liable for the judgment. The case explains the law behind piercing the corporate veil, and, unfortunately, is a good example of how fraud cases can take a long time to resolve.
If you are either in a contentious business bankruptcy or represent a creditor who believes a debtor is abusing the privilege of incorporation to escape debts, you need an experienced New York bankruptcy lawyer to handle your case.
For answers to more questions about bankruptcy, the automatic stay, effective strategies for dealing with foreclosure, and protecting your assets in bankruptcy please feel free to contact experienced Brooklyn bankruptcy attorney Bruce Weiner for a free initial consultation.