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Simple English definitions for legal terms
Piercing the veil
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A quick definition of Piercing the veil:
Piercing the veil is when a court holds a corporation's shareholders or directors personally responsible for the corporation's actions or debts. This happens when a shareholder uses the corporation to hide fraud or wrongdoing. However, courts are usually hesitant to do this because limited liability is important for encouraging investment in public markets. Only serious misconduct, like mixing personal and corporate assets or undercapitalization, can justify piercing the corporate veil. Creditors cannot go after shareholders unless the corporation was created fraudulently to avoid liability. Laws about piercing the corporate veil are different in each state.
A more thorough explanation:
Piercing the veil, also known as "piercing the corporate veil," is a legal concept that allows courts to hold a corporation's shareholders or directors personally liable for the corporation's actions or debts. This happens when the court decides to set aside the limited liability protection that corporations usually enjoy.
For example, let's say a company is formed to sell a product that is known to be dangerous. The company's shareholders know about the danger but decide to sell the product anyway. If someone is injured by the product, they may be able to sue the shareholders personally, rather than just the company, because the shareholders knew about the danger and still chose to sell the product.
Veil piercing is most common in close corporations, which are corporations with a small number of shareholders who are often involved in the day-to-day operations of the company. This provision prevents a shareholder from using control of a legal person to conceal a fraud, an abuse of rights, or a violation of a rule of public order.
While the law varies by state, generally courts have a strong presumption against piercing the corporate veil, and will only do so if there has been serious misconduct. Courts understand the benefits of limited liability, as it "encourages development of public markets for stocks and thus helps make possible the liquidity and diversification benefits that investors receive from those markets."
In general, creditors have no recourse against corporate shareholders, as long as formalities are satisfied. When, however, the corporation is fraudulently created to escape liability, then creditors may pierce the corporate veil.