What Does “Piercing the Corporate Veil” Mean?
If you own a business, you probably have heard about the “corporate veil” and perhaps wondered what it is. In Colorado, a corporation is formed when its organizers file articles of incorporation with the Colorado Secretary of State’s office; to create a limited liability company, the organizers file articles of organization. When this happens, a separate legal entity is created distinct from the company’s officers, directors, and owners.
The “corporate veil” is a legal fiction. It’s the idea that a veil separates the corporation from its owners, officers and directors. This illustrates the fact that the company is a separate legal entity independent of the people who own and manage its affairs.
Colorado courts firmly agree that as a general rule the corporation’s debts belong to the corporation only. The corporation’s officers, directors, and owners are not responsible for paying the company’s debts with their own money if the company doesn’t pay.
As with any general rule, there are exceptions. Piercing the corporate veil is one of the exceptions. This occurs in a lawsuit when equitable principles require a court to “pierce the corporate veil” to hold the owners of a company personally responsible for paying a judgment obtained against the company. Equitable means fair.
In Colorado, a person who wants the owners of a corporation to pay a business debt must prove three things:
(1) the owners and corporation are alter egos of each other;
(2) justice requires recognizing the substance of the relationship over the corporate form because the corporate fiction has been utilized to perpetrate a fraud or defeat a rightful claim; and
(3) piercing the corporate veil would produce a fair result.
All three things must be proven with clear evidence. These requirements were discussed in the following decisions of the Colorado Supreme Court: In re Phillips, 139 P.3d 639, 643-44 (Colo. 2006); and Leonard v. McMorris, 63 P.3d 323, 330 (Colo. 2003). In these and other decisions, the Colorado Supreme Court, recognizing that piercing the corporate veil is an extraordinary legal remedy, directed the trial courts not to pierce the veil without a very clear showing it is warranted.
“Alter ego” is Latin that essentially means your other self, or the opposite side of yourself. In the corporate context, it means that the corporation is a “mere instrumentality” for the transaction of the owners’ own affairs, and there is “such unity of interest in ownership that the separate personalities of the corporation and the owners no longer exist.” In re Phillips, 139 P.3d at 644. Colorado courts look at eight factors to make this determination: (1) whether the corporation is operated as a distinct business entity; (2) whether personal and corporate funds and assets are commingled; (3) whether adequate corporate records are maintained; (4) whether the nature and form of the entity’s ownership and control facilitate misuse by an insider; (5) whether the business is thinly capitalized; (6) whether the corporation is used as a “mere shell;” (7) whether shareholders disregard legal formalities; and (8) whether corporate funds or assets are diverted to non-corporate purposes. These factors reflect the underlying principle that the court should pierce the corporate veil only when the corporate form has been abused.
In the case of Leonard v. McMorris, the Colorado Supreme Court ruled that the officers of NationsWay, a major transportation company in Chapter 11 bankruptcy, were not personally liable to pay unpaid wages owing to NationsWay employees even though the Colorado Wage Act requires employers to pay wages on a regular pay schedule and also defines employers to include “any agent or officer” of the company. C.R.S.§ 8-4-101(6). After reviewing the statute and its legislative history, the Court concluded that it found nothing to evidence that the state legislature had intended that including officers and agents in the statutory definition would supercede Colorado’s otherwise applicable corporate law. The Court concluded that the statutory language makes officers and agents liable for the corporation’s legal obligation to pay wages only in their representative capacity as officers and agents of the company, but not personally.
So, piercing the corporate veil means to persuade a court to depart from the general rule that a corporation’s officers, directors, and owners are not responsible for paying a judgment company’s debts. Decisions of the Colorado Supreme Court, which are binding on all the other Colorado courts, make it clear that this is an extraordinary remedy that will be available only in limited circumstances.
This does not mean, of course, that owners, directors and officers can sit back and not worry about this issue. In future posts I will discuss how the courts evaluate the eight factors, decide whether a fraud has been perpetrated, and decide whether it would be fair to pierce the corporate veil.