The creation of a formal corporate entity and compliance with state prescribed formalities can offer business owners and members substantial protections from individual liability for business debts when acting by and through an entity. That protection, however, is not a given. In order to enjoy the benefits that limited liability entities afford, one must respect established corporate formalities and comport business practices accordingly.
Generally, corporate entities enjoy the presumption that an entity is legally separate from its individual shareholders or members, such that individual shareholders/members are not liable for an entity’s liabilities. Certain actions by shareholders/members, however, can lead the courts to pierce that liability protection, often called the “corporate veil,” and impose individual liability for facially corporate actions. Thus, it is imperative to understand what behavior can cause such a result.
Shareholder/members, or even other controlling or related entities, may find themselves liable for corporate debts where it is evident that those shareholders/members, or other controlling or related entities, are using an entity for their personal objectives. My Bread Baking Co. v. Cumberland Farms, Inc., 233 N.E.2d 748, 751–52 (Mass. 1968). Further, in Massachusetts, piercing the corporate veil may be appropriate in instances,
(a) when there is active and direct participation by the representatives of one, apparently exercising some form of pervasive control, in the activities of another and there is some fraudulent or injurious consequence of the intercorporate relationship, or
(b) when there is a confused intermingling of activity of two or more corporations engaged a common enterprise with substantial disregard of the separate nature of the corporate entities, or serious ambiguity about the manner and capacity in which the corporations and their respective representatives are acting. Id.
More specifically, the courts consider and weigh twelve factors when considering whether piercing the corporate veil is appropriate in any given case. Court consider whether there exists:
(1) Common ownership;
(2) Pervasive control;
(3) Confused intermingling of business activity assets, or management;
(4) Thin capitalization;
(5) Nonobservance of corporate formalities;
(6) Absence of corporate records;
(7) No payment of dividends;
(8) Insolvency at the time of the litigated transaction;
(9) Siphoning away of corporate assets by the dominant shareholders;
(10) Nonfunctioning of officers and directors;
(11) Use of the corporation for transactions of the dominant shareholders; and,
(12) Use of the corporation in promoting fraud.
Pepsi-Cola Metropolitan Bottling Co., Inc. v. Checkers, Inc., 754 F.2d 10, 14-16 (1st Cir.1985).
Not all factors need apply to justify the disregard of a corporate form, however, all are considered in the determination of whether or not the protections afforded by corporate formality are being abused to an extent that warrants piercing. Thus, people conducting business by and through various formal corporate entities would be well advised to ensure that their business practices observe corporate formalities, to ensure that they retain the protective benefits such entities generally afford. If you have questions with regard to business formation and/or operations you should consult with a knowledgeable attorney to determine your best options.