The phrase, “piercing the corporate veil,” relates to a circumstance in which a claimant is attempting to hold individuals (shareholders or members) liable for the debts and/or obligations of the entity. This issue is also confronted in a parent-subsidiary structure when the claimant is seeking to hold the parent liable for the debts and obligations of the wholly owned subsidiary. Courts are faced with applying a balancing test in deciding as to whether or not the corporate veil should be pierced in the above described circumstances.
The factors to be reviewed and method of applying the balancing test may vary from state to state; however, most state law or court decisions proclaim that the piercing of the corporate veil to expose shareholders and members to personal liability should be an extra-ordinary event. The Rhode Island courts generally apply a balancing test on a case-by-case basis, which is a similar approach to Delaware, by considering the following factors:
- Capitalization of the entity;
- Interlocking boards;
- Who are the officers and what is their authority;
- Do the shareholders/members share premises with the entity;
- Do they not deal together at arm’s length;
- Is there confusion in the marketplace over the entity being part of the shareholder;
- Were corporate formalities observed, including keeping of separate financial and corporate records;
- Did the shareholder regularly siphon off cash of the entity;
- Did the shareholder provide or arrange the entity’s capital in the form of loans so that the corporation was “thin”;
- Did the entities use separate attorneys and professionals;
- Were employees shared;
- Did the shareholder guarantee the debts of the entity; and
- Does the fact pattern smell of fraud or sharp practices by which a counterparty would be misled to economic disadvantage?
In a parent-subsidiary structure, the analysis may involve capitalization; i.e., insufficient capital, or the advancing of loans by a parent to a subsidiary in less than arm’s length fashion, which can result in adverse tax consequences. Thin capital in the tax sense is not determinative of a piercing situation in corporate cases; however, this fact may inform a decision maker in applying a balancing test of all factors. Courts are generally reluctant to pierce the corporate veil unless the facts demonstrate that the pierced entity is a sham designed to defraud investors and creditors.
Piercing the veil may occur when a tort has occurred, a contract has been breached, a corporation has been party to a fraud, or when a corporation is a mere agent of shareholders. A common-sense approach would be to answer the following question: Has someone been injured by being misled materially. Rhode Island courts look to inequity, fraud, undercapitalization or in a parent-subsidiary circumstance, the domination by the parent of the activities and decision-making of the subsidiary. For more information, please contact Managing Principal Gary R. Pannone at 401-855-2601 or email [email protected].
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