Monday, August 4, 2008

Piercing the Corporation: The Veil Becomes a Wall

As a result of a recent decision by the 4th U.S Circuit Court of Appeals, the "veil" of immunity protecting the officers of a corporation from individual liability has become a "wall."

Proving Fraudulent Intent

In Perpetual Real Estate v. Michaelson Properties, the Court held that, in order to hold the officers or directors of a corporation personally liable for acts of that corporation, a plaintiff will have to prove actual legal wrong on the part of the officers or directors. This standard provides tremendous protection to officers and directors of corporations by dramatically increasing the burden of proof placed on the plaintiff.

By requiring evidence of actual legal wrong, the Court has placed an imposing barrier in front of every unpaid creditor. "Fraudulent intent" has always been something extraordinarily difficult to prove, since it requires a psychological probe into the mind of the defendant. In corporate fraud cases the actual wrong standard is particularly burdensome, since the only evidence of any such intent is likely to be in the form of letters and similar correspondence, all of which will be tucked away in the files of the defendant corporation-if the evidence exists at all.

Traditional Standards

Despite the seemingly far-reaching implications of the Court's ruling, the traditional evidence required to "pierce a corporation" will still figure prominently in any suit seeking to hold corporate officers or directors personally liable for corporate acts. In addition to evidence of actual intent, the plaintiff will generally need to prove that the corporation was really just an alter ego of the directors, and had no independent financial existence apart from the directors. In this vein, successful cases prove that:
  1. The directors and officers have co-mingled corporate funds/assets with their own personal assets, or diverted the corporation's assets for purely personal use or

  2. The corporation was so undercapitalized that it was clearly incapable of operating as a successful business and was, thus, merely a "nominal" corporation, consisting only of business cards and stationery.

Perhaps the most successful means of piercing a corporation is based upon the corporation's failure to maintain the "formalities" required by law. Most importantly, that it failed to file various documents with the State Corporation Commission. At the very least, its Articles of Incorporation must have been accepted by the State and a charter number issued.

Now more than ever, creditors should investigate corporations to whom they extend credit and insist on personal guarantees or collateral security. Corporate borrowers should maintain their corporate formalities, not commingle funds, and avoid even the appearance of fraud.

For more information or to retain legal counsel, please contact the attorneys at Gross & Romanick today.