One of our roles as corporate lawyers is to use the business organizations code and applicable case law to protect our clients with the principles of limited liability. Indeed, that is why our various corporate forms exist – to shield shareholders and owners from personal liability for obligations of the corporate entities. However, in certain cases, the law must also protect people from those who try to take advantage of legal formalities to perpetrate fraud on another person or business. That is to say, a corporation or other corporate form should not be misused as an unfair device to achieve an inequitable result or perpetrate fraud.
For these reasons, the Supreme Court of Texas has identified instances where the corporate fiction can be disregarded. In Castleberry v. Branscum, our state Supreme Court allowed “piercing the corporate veil” when the corporate form is being used as a sham to perpetrate a fraud, as an alter ego of another corporation, or as a means of evading an existing legal obligation, achieve a monopoly, circumvent a statute, or justify a wrong. When a court pierces the corporate veil, it disregards the corporation, and holds its shareholders liable by imposing a type of vicarious liability for an underlying cause of action.
Shortly after the Supreme Court’s decision, there was push-back from the corporate world, and our legislature in Texas decided to limit the ability to pierce the corporate veil, focusing on cases with the presence of actual fraud. Still, it is important for honest entrepreneurs and founders of corporations and other business entities to minimize the risk that a court will impose liability by piercing its veil.
Below are a few ways to minimize such risk:
- Adequately capitalize and insure your business entity.
- Avoid using a corporation as a mere conduit or shell.
- Ensure that an owner does not exercise excessive control over a corporation.
- Comply with all corporate formalities.
- Keep separate books and records between a corporation and its shareholders.
While these principles hold true with LLCs as well, courts have also applied less weight to the control factor for LLCs compared to corporations. If you are an entrepreneur and have been using business organizations, our firm can help you navigate the sometimes-murky waters of veil piercing.
At Padua Law Firm PLLC, our corporate practice group has counseled a wide variety of small and medium sized businesses in their corporate structures, formations, asset protection, and related corporate matters and formalities. Call us today to schedule a free consultation to discuss your case.