From the course: Business Law for Managers

What is the corporate veil?

From the course: Business Law for Managers

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What is the corporate veil?

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- You're watching this and you may be thinking, what the heck is a corporate veil? The only veil I know about is the wedding one. Well, you're on the right track. I'll explain. In the United States and many parts of the world, when a corporation or limited liability company, also known as an LLC, is filed under the law of the state and/or country, that company is considered to be its own legal entity. This means that it is separate from the owners, members, and shareholders who created it or own it. The entity can enter into its own contracts, it can incur debts, credits, revenue, and be liable to creditors. This is great because you don't want little Johnny's college fund on the hook for a bill owed by a creditor for your company. However, don't jump for joy just yet. In some cases, the courts will look at the liabilities of the company and hold the directors, officers, owners, and shareholders personally responsible. This concept is called piercing the corporate veil. The courts consider the veil, or alternate ego for individuals who would otherwise be liable for debts and responsibilities incurred by the company. Now, don't start emptying Johnny's college fund yet. This is not an everyday occurrence. The courts consider a few factors when determining whether individuals should be personally on the hook or the company. Was the company engaged in fraudulent activities? Has the company followed the formalities of its formation? For example, held meetings, drafted bylaws, kept separate accounts, et cetera. Whether there is one person or a small group of people in full control of the company? And was the company inadequately capitalized or underfunded? Meaning it never had enough money to ever be independent of the individuals in control of the company. In the case of small businesses, they are more likely to have their corporate veil pierced because they are less likely to follow formalities of a corporate structure. Also, they often are controlled by a very small group of people or just one person. However, large corporations, which you may be a manager of, are not off the hook either. Courts will also pierce larger corporations when they acquire smaller companies, called subsidiaries. The larger corporation is then called the parent corporation and it can transfer its debts to the smaller subsidiary. This is simply a way to avoid the parent corporation's liability and the courts are onto it. So, yeah, don't do this. There are several ways that a company can prevent the corporate veil from getting pierced, which I go over in this course. But I hope this gives you a quick and dirty on what this concept means and how it applies.

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