One major purpose of corporations and limited liability companies is to shield individuals from personal liability.
A creditor who successfully sues a corporation or LLC and receives judgment against it can ask the judge to “pierce the corporate veil,” making its shareholders or members personally liable for any debts incurred.
Fraud or Illegality
Courts have the power to expose a Delaware LLC when they discover it has been used fraudulently or illegally. Fraud can take many forms, from bankruptcy fraud and credit card scams to healthcare fraud, insurance fraud, identity theft and more specialized crimes related to certain industries.
Though legal definitions for each type of fraud differ, they typically involve one or more victims and a financial loss to them. Depending on how much is lost, penalties could include prison sentences or fines.
Cases have arisen that addressed the question of piercing the corporate veil. In two of these instances, courts pierced the LLC veil due to lack of assets to cover liabilities owed.
Courts may find it easier for courts to view an LLC as the “alter ego” of its members when lacking corporate formalities. However, in order for this view to be valid, the plaintiff must present facts that demonstrate there is a unity of interest and control between the defendant and LLC that makes them indistinguishable from each other.
Separate Entities
Forming a corporation or LLC to own your business offers greater asset protection than being a sole proprietorship. Furthermore, having your own separate entity helps shield you personally in the event that a customer or client sues your enterprise.
If the owners of a Delaware LLC use the company’s funds for personal gain, this would constitute an abuse of the entity’s separate existence and could lead to court piercing its veil. Courts take into account various factors like whether the entity has been properly registered with its state or other jurisdictions in order to determine if it’s being operated as its own legal entity.
Additionally, courts will consider evidence that a corporation or LLC was used for fraudulence or other improper purposes. For instance, if shareholders or members formed an entity without enough capital at formation to meet its contractual obligations or moved company assets out of reach of known creditors in order to prevent them from collecting their debt, then that creditor can be considered in collecting its judgment.
Shareholder or Member Liability
An LLC is a business structure that incorporates elements of both corporations, partnerships and sole proprietorships into one legal structure. Members of an LLC are taxed at their individual level like shareholders in a corporation or partners in a partnership, with limited liability just like stock owners in the company.
Many businesses are turning to Delaware limited liability companies (“DLLCs”) as an alternative to corporations. Under the DLLC Act, these entities provide numerous advantages over corporations, including flexibility in how they may be taxed.
The DLLC Act grants DLLCs the exclusive authority to “indemnify and hold harmless any member, manager, or other person from and against any and all claims and demands whatsoever.” This limit on personal liability and expansive indemnification rights compare favorably with Delaware corporation stockholders, officers, and directors’ protections.
Reverse Veil Piercing
In Delaware and other states, reverse veil piercing is a legal remedy available to creditors who wish to access the personal assets of judgment debtors who are also shareholders in a corporate entity. If they can successfully penetrate through the corporate veil and access an individual owner’s individual possessions, collecting on their judgment will be much simpler.
However, this approach could unfairly discriminate against innocent shareholders and creditors who depend on the corporate form to shield them from claims made by a controlling insider. In such cases, equity requires that piercing produce an equitable result rather than circumventing standard judgment procedures.
In Postal Instant Press and Curci Investments, the court acknowledged that reverse veil piercing may be appropriate under certain circumstances; however, it did not adopt this remedy due to judgments being against corporations with innocent shareholders in both cases. Furthermore, Curci involved an LLC owned by both a judgment debtor and his wife who already bore responsibility for any debts incurred.
