Is the End of the Corporate Liability Shield in Sight?

A few months back, the Delaware Courts issued a legal decision that has the potential of completely up-ending the notion of limited liability for shareholders by virtue of hiding behind their corporations. It has been described as a Reverse Piercing of the Corporate Veil.

First some background. The creation and use of a corporation is ideal for shielding the owners (shareholders) of the company from the liability of the business. If you own Tesla stock, you’re not going to be sued, individually, if Tesla fails to pay its vendors. That would be liability for the corporate entity to handle. In order to preserve this liability shield, certain formaliites must be maintained. Otherwise, a creditor can ask a court to pierce the veil (ie: liablity shield) and seek to make the shareholders liable for the corporate obligations.

But now, Delaware is changing the ground rules.

As the American Bar Association notes, “there are two types of reverse veil-piercing, the court explained: insider veil-piercing and outsider veil-piercing. Insider veil-piercing occurs where a controlling LLC member asks a court to disregard the corporate entity that separates the member from the corporation. Outsider veil-piercing is implicated when a third-party creditor urges a court to impose liability on a company for a judgment against its member, the court explained.”

“The court announced an eight-factor test, which includes the five factors involved in traditional veil-piercing, to determine the propriety of reverse veil-piercing to a particular case. None of the eight factors are dispositive, and the court must ensure innocent shareholders or other creditors are not harmed by the decision to allow reverse veil-piercing to satisfy a judgment. Some key factors include disregard of corporate form, extent and severity of wrongful conduct, and the extent to which reverse veil-piercing will harm third-party creditors of the entity the plaintiff seeks to pierce.”

It’s likely that Ohio wouldn’t change its current law for, at a minimum, years into the future. But it is something to keep in mind as you seek to protect that which is yours.

To read the ABA article, click here.

To read the court opinion, click here.