Nov 2024 Newsletter – Protection From Corporate Veil Piercing

Protection From Corporate Veil Piercing
of Corporations/LLCs

Often times individuals will form privately held businesses as corporations or limited liability companies and enjoy the protection from personal liability that these formal entities offer. In the February, 2012 case of Walmsley v. Ehmann, the Superior Court of Pennsylvania stated that the corporate veil may be pierced by courts as a “means of assessing liability for the acts of a corporation against an equity holder in the corporation.” Notwithstanding this legal dictum, this Appellate Court decided against piercing the corporate veil and held that in Pennsylvania there is a strong presumption against piercing the corporate veil of an entity. The Court found that any inquiry into whether to pierce the corporate veil of a company must “start from the general rule that the corporate entity should be recognized and upheld, unless specific, unusual circumstances call for an exception.

In Pennsylvania, the courts will consider the following non-exhaustive list of factors when deciding whether to pierce the corporate veil of a company:

(1) undercapitalization;

(2) failure to adhere to corporate formalities;

(3) substantial intermingling of corporate and personal assets; and

(4) use of the corporate form to perpetrate fraud.

The court’s main goal is to see if any justification exists for “disregarding the corporate form and the traditional insulation it provides from personal liability”. Simply put, the court looks to see if an individual is abusing the corporation to further his/her own personal interest.

Based on the following legal analysis, in Walmsley, the Court did not pierce the veil of a limited liability company whose sole purpose was to own the stock of another entity.

Undercapitalization

The Court stated that the corporate formalities of a LLC “are few and, depending on the purpose of the LLC, it may not need to be capitalized at all.” This Court found that when considering capitalization it must consider whether there was proper capitalization at the time of formation to meet the debts that may be expected to arise in the normal course of business. The Court noted that many companies may be undercapitalized if they suffer from a period of financial losses and this is not a per se reason to pierce the corporate veil. In Walmsley, the Court found that the LLC was established to hold the stock of another corporation and did not engage in any other business, therefore, no capital was required when the business had such a narrow scope.

Corporate Formalities

The Court first noted that the requirement to adhere to corporate formalities is lessened for limited liability corporations (“LLC”) and closely held corporations. Corporate formalities include, but are not limited to, filing articles of organization or incorporation, obtaining a federal employee identification number, filing federal tax returns, and maintaining financial statements, bank accounts and executive office space. In Walmsley, the Court found the LLC “was not required to strictly adhere to corporate formalities” required of a C corporation. The court noted that it considers whether the lack of formalities is connected to misuse of the entity or led to harm the creditors of the entity when attempting to justify if the corporate veil should be pierced.

Intermingling of Corporate and Personal Assets

In Walmsley, the Court specifically noted that there were no intermingling of personal and corporate assets, even though the individual members of the LLC received tax benefits due to the structure of the LLC and the stock the LLC owned. However, the intermingling of assets is one of the important factors that privately held companies often ignore to their detriment. Courts look at whether intermingling exist as an indicator that individuals do not view the corporation or LLC as a separate entity and that the corporate form is being abused for the personal benefit of the shareholders/members. Therefore, it is wise to keep personal and business expenses and assets separate.

Perpetration of Fraud

In Walmsley, the Court did not find evidence that the LLC was used to perpetrate fraud on its creditors. However, if such evidence is found it is highly likely that the corporate veil will be pierced. Fraud is a clear indicator that the corporate form is being abused to the 5 detriment of others and therefore, the courts will not continue to grant the shareholders the personal protections offered by the formation of the entity.

If you have any questions on how to properly structure your business to avoid creditors being able to pierce the corporate veil of your privately held business and make you personally liable, please contact this office for further advice and counsel.