Piercing the “Corporate Veil”

Under normal circumstances the corporation can insulate its shareholders and inside employees from personal liability. In fact, historically, the primary reason for incorporating a business is to prevent a creditor from attaching the personal assets of the individual shareholders. If the corporation is maintained and run as a separate entity, properly funded and avoids paying personal liabilities of its shareholders, this “Vail” can not be broken.

But if a court finds that the corporation was formed merely to shield its shareholders from their unlawful acts, then the court can order personal liability of the shareholders. In the landmark case of Belvedere Condominium Unit Owners' Ass'n v. R.E. Roark Cos., (1993) 67 Ohio St. 3d 274, The Supreme Court of Ohio promulgated criteria to justify the piercing of the corporate veil that would allow creditors to obtain personal liability of the shareholder.

In its synopsis the court stated:

“A fundamental rule of corporate law is that, normally, shareholders, officers, and directors are not liable for the debts of the corporation. An exception to this rule was developed in equity to protect creditors of a corporation from shareholders who use the corporate entity for criminal or fraudulent purposes. Under this 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. Courts will permit individual shareholder liability only if the shareholder is indistinguishable from or the alter ego of the corporation itself.

In defining its exception, the court went on to say:

“The corporate form may be disregarded and individual shareholders held liable for corporate misdeeds when (1) control over the corporation by those to be held liable was so complete that the corporation has no separate mind, will, or existence of its own, (2) control over the corporation by those to be held liable was exercised in such a manner as to commit fraud or an illegal act against the person seeking to disregard the corporate entity, and (3) injury or unjust loss resulted to the plaintiff from such control and wrong.”

Over the years, these three criteria were refined to allow piercing of the corporate veil under various circumstances including, payment of personal expenses from corporate funds, undercapitalizing the corporation, using the corporation to shield the individual shareholder from statutory violations such as building code violations, banking laws, and financing law violations.

In reading the criteria, it appears that the criteria is quite burdensome. But recent court cases have eased what appears to be a draconian reading of these rules. In Dombroski v. WellPoint, Inc., 119 Ohio St.3d 506, 2008 Ohio 4827, the Ohio Supreme Court lessened the burden to litigants as it pertains to the second prong of the test, “...as to commit fraud or an illegal act against the person seeking to disregard the corporate entity.”

In its opinion the court expanded this criteria to include “...similarly unlawful act[s].” Of course, the court failed to define this term. Therefore, many courts sought to determine the court’s meaning. Many courts have attempted to define this verbiage using the Supreme Court’s statement that "[c]ourts should apply this limited expansion cautiously toward the goal of piercing the corporate veil only in instances of extreme shareholder misconduct."

A 2009 case in the Fourth Appellate District (Jackson County, Ohio) is typical of this attempt at interpretative jurisprudence. The case, Stewart v. R.A. Eberts Co., 2009 Ohio 4418, involved the purchase of a coal mine. As part of the agreement, the Plaintiff was to receive royalties of $1.00 per ton of coal. The Plaintiff attempted to obtain personal liability of the shareholders and directors. Apparently, the corporate entity that was to pay the plaintiff was unable to do so.

The Plaintiff argued that the second criteria was too restrictive; that the Supreme Court’s second criteria included "unjust or inequitable conduct.” The court rejected the Plaintiff’s argument citing the Dombroski case stating that the Plaintiff's interpretation was too liberal; that "unjust or inequitable conduct” did not rise to the level of "fraud, an illegal act, or a similarly unlawful act."

So what do we conclude from these cases:

1. That courts are still in flux regarding the interpretation of the criteria to pierce the corporate veil, and

2. That courts look to the actions of the insiders to interpret the three criteria, and

3. The actions of the insider must be unlawful, not just unjust or inequitable, i.e. fraudulent conveyance of assets, conversion of assets, etc., and

4. The interpretation of the jurisprudence set forth in Belvedere must be done on a case by case basis to determine whether the facts in that particular case meet the criteria to pierce the corporate veil.