The following debate questions whether the ‘piercing of the corporate veil doctrine’ benefits the limited liability companies. The particularity of this form of company is that it allows limited liability to its owners. The ‘piercing of the corporate veil’ doctrine allows for the otherwise immune corporate officers, directors, or shareholders to be held liable for the corporation’s wrongful acts.
Keep reading the interesting arguments put forward by our debaters, to decide whether this doctrine benefits the limited liability companies.
Jana Bencova
Jana graduated from the Masaryk University in the Czech Republic and practiced law at the Supreme Court of the Czech Republic and in a law firm in Slovakia. During her practice she has provided legal advice mainly in fields of commercial law, intellectual property, litigation, public procurement, and arbitration. Last year she passed the Slovak bar exams entitling her to practice law as an attorney. Currently, she is studying LLM program in International Business Law at Central European University in Budapest.
Albana Karapanco
Albana Karapanço graduated from the University of Tirana, Faculty of Law in 2010. She holds a LLM degree from University of New York Tirana and currently is a LLM Candidate at Central European University (International Business Law program) in Budapest, Hungary. She is an attorney at law in Tirana, Albania and has worked for some years in insurance and pension funds field.
Opening Statement - Jana
According to the Black´s Law Dictionary, the doctrine of piercing the corporate veil is defined as „the judicial act of imposing liability on otherwise immune corporate officers, directors, or shareholders of the corporation´s wrongful acts” (Garner, 2009). I argue that application of this doctrine benefits the limited liability companies (LLCs).
The doctrine leads to disregarding the fact that a company and its shareholders are separate legal entities (Kosmopoulos v. Constitution Insurance Co., 1987). This can be crucial in cases when the shareholder, which is in many times the parent company with regard to the LLC in question, interferes with the activities of the subsidiary and as a result, the company´s operations are influenced in various different ways by the interests and decisions of the shareholder. If such operations cause harm to the company or its creditors, it is fair to hold liable the shareholder.
Several examples suggesting that the doctrine of piercing the corporate veil prevents unfairness and benefits the company, can be found. I will point only to the most important ones that arise in the context of bankruptcy and criminal proceedings and in connection to the fraudulent conduct.
In the bankruptcy proceedings in some jurisdictions, the persons that are otherwise separate and immune from the company´s debts can be held liable, if the company goes bankrupt and the company´s creditors cannot satisfy their claims because the assets of the company are insufficient. The rationale behind is that although the separation between the company and its shareholders exists by definition in law, in practice many times the shareholders conduct the company´s business while their actions, such as undercapitalization or reckless borrowing, can lead the company into insolvency.
The doctrine can prevent unfairness also with regard to the criminal liability. This is the case especially when an offender uses the company as a “façade” (Jones v. Lipman, 1962) or a shield to hide his/her acts that constitute a criminal offence for which he/she would otherwise be criminally liable. For example, a parent company profits from the activities of its foreign subsidiary company that cause environmental damage. In such cases the doctrine permits to hold the parent company liable for the damages, provided that the parent company has a decisive impact on the subsidiary´s actions and therefore the activities of the subsidiary and the parent company are closely linked. But the doctrine can apply also to other persons acting wrongfully besides the company´s shareholders. Particularly directors, managers or other persons entitled to act in the name of the company can commit a criminal offence (Crown Prosecution Service v. Jennings, 2008). Since the act is legally the act of the company, the company should be liable. However, it is fair, under certain requirements, to hold liable also (or instead) the acting person.
Moreover, the corporate veil can be pierced as a remedy against an act that would under specific conditions constitute fraudulent conduct. For instance, a person acting on behalf of the company (such as a director) or the company´s shareholder can cause the other party to a contract to believe that he/she is in fact contracting with the person who has a personal liability over the debt arising there from, instead of (or in addition to) the liability of the company (Macey, 2014). In such a case, it would be in many cases unfair for both the company and the creditor, to hold liable only the company.
In conclusion, I have argued that the doctrine of piercing the corporate veil aims to prevent unfairness resulting for a company from the activities of otherwise immune persons and I provided some examples that support this argument. On the basis of the foregoing it can be concluded that the doctrine and its application benefits the companies.
Opening Statement - Albana
The notion of limited liability of a company is presently well established in both common law (referring herein to United States and United Kingdom) and civilian law systems (referring herein to the member states of the European Union) (Becker 2002). The limited liability concept arose out of the need to protect the investors, consequently helping enterprises’ growth, and though it originated in Europe, it was recognized in United States in early times. (Vanderkerckhove, 2007). In simple terms, without entering into the differences of incorporated and unincorporated forms, it means that the members (owners) of a limited liability company (LLC) are not held liable for the obligations or debts of the entity.
Piercing of the corporate veil is an equitable remedy that changes the financial risk that shareholders had anticipated and relied upon (Soderquist et all, 1997). The liability is extended to immune corporate officers, directors, or shareholders for the wrongful acts of the company (Garner, 2009). The veil piercing was created in United States but it is met in European legal systems in diverse forms and approaches, mostly under the vesting of shareholder liability (Vanderkerckhove, 2007).
The doctrine does not benefit LLCs from legal and economic perspectives. First, the limited liability gives to the entity the most attractive feature in doing business and valuable contribution to the economic progress (Cortenraad, 2000). Currently LLC represents an important vehicle of doing business worldwide. The lifting of the veil challenges the legal personality of the company (Salomon v A Salomon and Co Ltd [1897] AC 22) that is distinct from its members and a cornerstone of company law. Additionally, it puts the shareholders in uncertain and unpredictable situations.
Second, the limited liability decreases monitoring costs from shareholders to managers and other shareholders (Wheeler, 1993). On the contrary, the uncertainty of the liability makes the shareholders very active and they intervene in management operation. Thus, the managers are not allowed to perform their duty and act efficiently. Despite leaving the delegated control to specialists, shareholders will look after their assets creating a chaotic situation (Dooley, 1995).
Third, crucial arguments against the prevalence of the doctrine are the substantial economic benefits deriving from the limited liability notion. Some advantages of limited liability are the diversification of investment, increase of liquidity of shares, and undertaking useful risky projects (Smith, Ssrn). Investors are willing to invest if they are not exposed to the risks and the whole society benefits from it (Vanderkerckhove, 2007). The prevalence of the doctrine would discourage the participation in the capital markets and impair large corporations (Dooley, 1995).
Also, when piercing the corporate veil, courts take into consideration different factors and circumstances. Although courts rely on labels or characterizations such as alter ego, instrumentality, sham, it is viewed that case law has not shown any sensible rationale or policy why several factors are decisive (Garner, 2009).
The abolition of the corporate veil may be very radical, but the decision to lift the veil and hold responsible the people behind the entity must be strict. If not, it will lead to uncertainty and unpredictability. Instead of bringing social benefits, it would lead to abuse. In my opinion it is advisable that parties entering into contractual relationship with LLCs provide for ex ante measures and do not rely on the veil piercing as an ex post measure due to disadvantages previously mentioned.
One has to bear in mind that the issue itself is complex and must keep in mind the remarkable statement of Justice Cardozo that the concept of piercing the corporate veil “is still enveloped in the mists of metaphor. Metaphors in law are to be narrowly watched…they end often by enslaving it.” (Becker 2002)
By now, we have learnt that the ‘piercing of the corporate veil’ doctrine can both benefit and work against the LLCs. On one hand, Jana argues that this doctrine benefits the LLCs because the shareholders should be held liable for their unlawful actions, not the company itself. On the other hand, Albana argues that the doctrine does not benefit the LLCs since it will prevent the shareholders to invest and take financial risks.
Rebuttal - Jana
My opponent presented several arguments why, in her opinion, the doctrine of piercing the corporate veil does not benefit LLCs.
Firstly, she argues that LLC is a very attractive entity for doing business mainly because the shareholder´s personality is separated from the company´s personality. According to her, the limited liability has many advantages; especially it encourages diversified and risky investments. However, it does not provide any supporting arguments suggesting that the doctrine makes investing in a LLC less attractive, or that founders and shareholders are discouraged from establishing or entering into a LLC as a consequence of the doctrine. Therefore her argument has to be rejected. My argument is that LLC remains to be a very popular form of company for the investors despite the fact that the corporate veil can be in exceptional cases pierced. It should be stressed that the limited liability of the shareholders remains a basic rule prevailing most of the time, while application of the doctrine is only an exception to this rule which should be applied restrictively.
My opponent further argues that the doctrine puts the shareholders in uncertain and unpredictable situations. From this statement, however, it does not follow that the company (as opposed to its shareholders) does not benefit from it. On the contrary, as showed in my opening statement, the doctrine often improves the situation of the company as it corrects unfairness caused by the shareholders.
Similarly, the opponent argues that the limited liability decreases monitoring costs of the shareholders. Again, this fact, if true, only means that increased monitoring costs put the shareholders into a worse position, but not necessarily the company itself. On the contrary, the company will usually benefit from the fact that the shareholders are more aware of possible consequences of their acts if the corporate veil can be pierced. This makes them diligent and it prevents them from undertaking actions that could cause harm to the company.
Excessive activism and intervention in the management of the company by the shareholders also does not support the statement that the doctrine does not benefit LLCs. Although, there might be such efforts by the shareholders, they are limited by statutory and contractual provisions. The competences of the managers are specified in law and there are very limited possibilities for the shareholders to interfere with them.
Furthermore, the opponent states that the case law does not provide for any sensible rationale for the factors that are decisive when piercing the corporate veil. Firstly, it does not follow how this statement proves that the doctrine does not benefit LLCs, and secondly, this statement is in my opinion oversimplified. Each individual case decision, not only one relating to the piercing of the corporate veil, has its reasoning and arguments that are applicable to the particular facts in question. Sometimes, it might be difficult to deduct general rules, but this is the case for many other legal doctrines.
The opponent further argues that the piercing should be applied strictly, because it can lead to uncertainty and unpredictability or even to abuse. Firstly, the opponent does not further develop the argument regarding possible abuse. But in my opening statement it was shown that it is rather the limited liability that is often abused to the detriment of the company. Secondly, the doctrine is actually applied strictly, because it is only an exception to otherwise prevailing rule of limited liability of the shareholders.
Finally, the opponent suggests that ex ante contractual measures should be adopted instead of relying on the doctrine. I agree that ex ante measures are advisable; however if they are not in place or if they nevertheless fail to provide a fair outcome, the doctrine can operate in order to correct the unfairness.
Rebuttal - Albana
While analysing the piercing of the corporate veil, the main argument that goes in its favour is the fraudulent conduct of the people behind the entity. My opponent focuses on the fraudulent conduct in the context of bankruptcy and criminal proceedings mentioning the remedial nature of the doctrine itself and concluding that as a means of preventing unfairness, it benefits the companies. These arguments do not weaken all the disadvantages the doctrine brings to the companies.
The incentive provided to the business by limited liability has been considered a very important legal development of the nineteenth century (Barber, 1981). Though years have passed “limited liability” continues to contribute to the development of commerce and economy, because shareholders are not afraid to take risks.
My opponent argues that the doctrine prevents unfairness and benefits the company. It is accepted that the veil piercing is an ex post facto remedy used to justify the liability of shareholders, directors and managers. Hence, the piercing of the veil is decided by courts after the events have taken place and more than precautionary nature, it may keep away the investors and frightens directors or managers to work on that position. On one side, the investors/shareholders main argument is that they decide to start a business only because they risk up to their contribution. While on the other side, the directors and managers are protected by the business judgment rule and are not held personally liable as long as their decision serves to the best interest of the entity (Caudill, 2003).`
Bankruptcy or insolvency of the company does not necessarily means that the veil must be pierced to satisfy the creditors’ claims. Several other grounds and factors must be taken into account. Judge Posner in On Command Video Corp. v. Roti opined that: “… A person who signs a contract after months of negotiation is in a position to determine whether his counterparty is solvent, and if he makes no effort to do so…he’s on weak ground complaining if the other party turns out to be insolvent”. In similar cases, the reliance on the doctrine may impair the reputation of the company and the people behind it. Therefore, parties must look after their interest and not counting and claiming the piercing of the corporate veil as the first solution to the problem.
Additionally, the academic literature is characterised by confusions, incoherencies, and contradictions on the doctrine application. Thus, the conviction how the doctrine benefits the companies is not straightforward. If the benefits of the LLC were so evident, the courts would not struggle from case to case whether to pierce or not and trying to balance all the advantages and disadvantages involved. As a general rule, courts are reluctant to pierce the corporate veil and the grounds on which the veil must be pierced are not clearly established. It follows from this that the decision may be highly subjective and may vary from one court to another.
In order to prevent the veil piercing due to all advantages it provides, more can be done with regard to the compliance with the formalities and LLC supervision.
Even if the limited liability of the company has been set aside and courts have held decisions on the issue, this does not imply that the piercing of the corporate veil may be perceived as a trend. The impact of the doctrine on the business, resulting in market and economic consequences, most likely may show the need to reconsider the doctrine and require its application only under strict specific situation when it may be considered as the last remaining remedy favouring the public good. The veil piercing does not benefit LLC, but imposes ambiguity, uncertainty and additional unnecessary costs.
We have now seen how each debater formulated solid counter-arguments to the arguments of their opponent. On one hand, Jana demonstrates that there is no proof of any kind to indicate that the LLCs will not be anymore an attractive form of investment if the doctrine is applied. On the other hand, Albana shows that since the doctrine is not coherent enough it create uncertainties for both the shareholders and the judges who have to apply it and the same results which should be achieved through this doctrine can be reached by implementing a more thorough supervision system over LLCs.
I hope you enjoyed the debate and the conclusions will help you form an opinion of your own!
Conclusions - Jana
A general conclusion that the doctrine does not benefit LLCs, as stated by my opponent, has to be rejected, because such a broad statement was already disproved by some of a number of examples found in case law where the doctrine actually proved to be beneficial. I previously stressed that the doctrine has an exceptional character, which is also an answer to the two additional arguments my opponent presented, mainly that the application of the doctrine is inconsistent and that the doctrine impairs the reputation of the company. Firstly, the doctrine is applied exceptionally in order to correct unfairness and the unfairness is far from being defined or settled. This, together with different facts and circumstances in individual cases, explains to a large extent the argued inconsistency. Secondly, it is not clear how could the doctrine that is used only ex post and exceptionally, impair the reputation of a particular company. If anyone´s reputation is at stake, it is the reputation of those persons that are eventually held liable.
Finally, it is undisputable that nobody should count on that doctrine and I do not think any reasonable person actually does. On the contrary, any subject entering into a commercial relationship with a company should be vigilant and cautious. Nevertheless, this does not disprove a conclusion that, despite possible disadvantages, the doctrine does benefit LLCs, mainly when the circumstances of the case do not allow other remedies to correct unfairness.
Conclusions - Albana
As discussed in my opening and counter arguments, it is clear that the prevalence of piercing the corporate veil doctrine does not benefit LLCs. The limited liability notion protects the existing investors and attracts the new ones. Putting the limited liability concept in question, more than legal concerns may affect the market. If investors are not willing to invest and directors and managers fear the consequences of their decision, the situation will not be desirable.
The issues argued by my opponent with regard to bankruptcy and criminal liability are possible but they do not provide the rationale how the LLC itself benefits from them. Indeed, the veil piercing is a remedy to the creditors and serves to the public interest but the arguments of the opponent are not clear how the prevalence of the doctrine benefits the LLC. Simply put, an exception to the rule must not be considered beneficial in broad terms.
Finally, the disadvantages that the prevalence of the doctrine brings to the LLCs are clearly articulated. The prevalence impairs not only the LLC as a well accepted and successful entity but also the market. Hence, parties must provide for their protection and the doctrine must be applied as the last resort.
