Piercing the Corporate Veil: A General Overview of the Exception Creditors Can Use to Find Individual Shareholders Liable for Corporate Debts

by David S. Brown, Esq.

A fundamental rule of corporate law is that shareholders, officers and directors are not liable for the debts of the corporation.[1] In this respect, individuals find the corporate form useful because it creates a division between shareholders and their business concerns.[2] Simply put, the corporate form insulates individual shareholders from being held liable for corporate wrongdoings or debts. The Ohio Supreme Court summarized this concept by stating that, “the corporate form has been introduced for the convenience of the company in making contracts, in acquiring property for corporate purposes, in suing and being sued, and to preserve the limited liability of the stockholders, by distinguishing between the corporate debts and property of the company, and of the stockholders in their capacity as individuals.”[3]

As with most rules, an exception has been developed in equity to protect creditors of a corporation from shareholders who use the corporate entity for criminal or fraudulent purposes.[4] To this end, the Supreme Court has made clear, “[t]hat a corporation is a legal entity, apart from the natural persons who compose it, is a mere fiction, introduce for convenience in the transaction of its business, and of those who do business with it; but like every other fiction of the law, when urged to an intent and purpose not within its reason and policy, may be disregarded.”[5] Thus, individual shareholders may be found liable to third parties for their own bad acts, regardless of the protections afforded by the corporate form, when they use the corporation “for criminal or fraudulent purposes” to the detriment of a third party.[6] Under this “piercing the corporate veil” exception, the “veil” of the corporation can be “pierced” and individual shareholders held liable for corporate misdeeds when it would be unjust to allow the shareholders to hide behind the fiction of the corporate entity. This scenario most commonly plays out in circumstances where an individual shareholder is indistinguishable from, or the “alter ego” of the corporation itself.

In order to determine when the corporate form can be set aside and the veil pierced, the Supreme Court has established the Belvedere test. Under Belvedere, the corporate form may be disregarded and individual shareholders held liable for corporate debts if three key elements are met. The elements are: (1) The individual shareholder’s control over the corporation is so complete that corporation has no separate mind, will, or existence of its own; (2) The individual shareholder’s control over the corporation is exercised in such a manner as to commit fraud or an illegal act against the person seeking to disregard the corporate entity; and (3) An injury or unjust loss resulted to the plaintiff from such control and wrong.[7] All three prongs of the test must be met for piercing to occur.[8]

The Belvedere test focuses on the extent of the shareholder’s control of the corporation and whether the shareholder misused the control so as to commit specific egregious acts that injured the plaintiff.[9] The Court later amended the Belvedere test in Dombroski when it held that “to fulfill the second prong of the Belvedere test for piercing the corporate veil, the plaintiff must demonstrate that the defendant shareholder exercised control over the corporation in such a manner as to commit fraud, an illegal act, or a similarly unlawful act.”[10] The Court further stressed that “courts should apply this limited expansion cautiously toward the goal of piercing the corporate veil only in instances of extreme shareholder misconduct.”[11]

If a plaintiff is able to successfully prove each of the three elements enumerated in the Belvedere test, the result will be an individual shareholder being held liable for corporate misdeeds because it would be unjust to allow the shareholder to hide behind the fiction of the corporate entity.[12]  The exception has also been applied to ascertain whether a parent corporation could be held liable for its subsidiary corporation’s misconduct.[13]

It is important to note that piercing the corporate veil is not a claim, it is a remedy encompassed within a claim.[14] In other words, it is a doctrine wherein liability for an underlying tort or breach may be imposed upon a particular individual. In order to take advantage of this doctrine, a plaintiff’s complaint must simply contain allegations from which an inference fairly may be drawn that evidence on these material points will be introduced at trial.[15]

David Brown is an attorney practicing in Commercial Collections and is based in the Cleveland office of Weltman, Weinberg & Reis Co., LPA. He can be reached at 216.685.1062 and dbrown@weltman.com.

________________________________________

[1] Belvedere Condominium Unit Owners’ Assoc. v. R.E. Roark Cos., Inc. (1993), 67 Ohio St.3d 274, 287.
[2] Dombroski v. Wellpoint, Inc. (2008), 119 Ohio St.3d 506, 510.
[3] Id.
[4] Belvedere, supra. at 287.
[5] Id.
[6] Dombroski, supra.
[7] Belvedere, supra. at 289.
[8] Dombroski, supra. at 511
[9] Id. at 510
[10] Id. at 513
[11] Id.
[12] Minno v. Pro-Fab, Inc. (2009), 121 Ohio St.3d 464, 467.
[13] Id.
[14] Geier v. National GG Industries, Inc., 11th Dist. No. 98-L-172, 1999 Ohio App. LEXIS 6263.
[15] Id.

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