Piercing the corporate veil: Why it is done

On Behalf of | Jun 10, 2024 | Business Disputes

The “corporate veil” refers to the legal distinction between a corporation and its shareholders – which is generally designed to protect the latter from being personally liable for any of the company’s debts.

However, there are times when it may become necessary to try to pierce that corporate veil so that individuals can be held personally accountable for the business entity’s liabilities. 

Why piercing the corporate veil can be necessary

Piercing the corporate veil is a drastic step, and one that the courts do not take lightly. Fraud and misconduct are the top reasons that this kind of legal action is necessary.

Some people purposefully misuse the corporate structure to escape personal liabilities. If shareholders or directors fraudulently convey (transfer) assets to a corporation they control to hinder creditors. This typically involves situations when a debtor is facing personal insolvency and is anticipating bankruptcy or other legal action and they’re trying to place assets out of reach.

Fraudulent conveyance often involves transferring assets without receiving the equivalent value in return. For instance, selling a property significantly below its market value or gifting assets to a family member, friend or business associate without any consideration can be fraudulent if it leaves the debtor in question unable to meet their obligations. In many cases, this transfer is done with the intention of the debtor to retrieve the assets once their financial issues are resolved.

The timing of an asset transfer can be a crucial factor in determining fraudulent intent. Transfers may be made shortly before or after a creditor makes their claim, but the usual “red flag” is that the debtor is already facing financial difficulties. 

What are the potential options?

If a transfer is deemed fraudulent, the court can intervene to protect a creditor’s rights. The possible legal remedies for the creditor and consequences for the individual include:

  • Voidable transfers: Courts can declare a fraudulent conveyance void, effectively reversing the transfer. This means the asset is returned to the debtor’s estate and made available to satisfy creditor claims.
  • Recovery of assets via other means: Creditors may pursue legal action to recover the equivalent value of the transferred assets if those assets are dissipated or otherwise beyond reach. This helps ensure that creditors can collect on their legitimate claims despite the debtor’s attempt to hide or shield assets.
  • Punitive damages: In some cases, courts will impose punitive damages on the debtor for engaging in fraudulent conveyance. This serves as a deterrent against future fraudulent behavior and compensates creditors for their additional costs and the efforts they have to expend trying to recover their claims.

Debtors will usually seek to defend their actions by showing that the transfer was made in good faith for legitimate reasons, that the consideration given was fair due to unique circumstances (such as the state of disrepair of the assets, especially real estate) or that they were not actually insolvent or anticipating insolvency at the time. That can turn this kind of litigation into a hard-fought battle.

Fraudulent conveyance undermines the integrity of the financial system and creditor-debtor relationships. If you believe that a debtor is using their corporation to shield themselves from debts in a way that violates the law, it may be time to seek additional legal guidance that is tailored to the specifics of your situation.