Changes To Piercing The Corporate Veil

The Supreme Court of Ohio recently modified one part of a three-prong test for “piercing the corporate veil” (the method for bypassing the corporate structure to recover damages directly from a shareholder). In the decision, the Court held that when a plaintiff pursuing a civil lawsuit against a corporation seeks to pierce the corporate veil, the plaintiff must show that the shareholder used its control of the corporation “in such a manner as to commit fraud, an illegal act, or a similarly unlawful act.”

Previously, the test focused on the extent of the shareholder’s control of the corporation and whether the shareholder misused the control so as to commit specific egregious acts that injured the plaintiff. Specifically, the test stated that “the corporate form may be disregarded and individual shareholders held liable for wrongs committed by the corporation when (1) control over the corporation by those to be held liable was so complete that the corporation has no separate mind, will, or existence of its own, (2) control over the corporation by those to be held liable was exercised in such a manner as to commit fraud or an illegal act against the person seeking to disregard the corporate entity, and (3) injury or unjust loss resulted to the plaintiff from such control and wrong.”

Focusing on the second prong of the test, the Court noted that Ohio’s appellate courts interpreted the phrase “fraud or illegal act” in two different ways. Several courts of appeals liberally construe the language of the second prong. Their modified version of the second prong required the plaintiff to present evidence that the shareholders exercised their control over the corporation in such a manner as to commit a fraud, illegal, or other unjust or inequitable act upon the person seeking to disregard the corporate entity. The other, narrower view followed the plain language of the second prong and limited piercing to only those cases in which the defendant shareholder used its control of the corporate form to commit fraud or an illegal act.

Although noting that there were “compelling reasons” to adopt the more liberal construction of the test, the Court wrote: “Nevertheless, we continue to adhere to the principle that limited shareholder liability is the rule and piercing the corporate veil is the ‘rare exception’ that should only be ‘applied in the case of fraud or certain other exceptional circumstances.’”

The Court stated that limiting piercing to cases in which the shareholders used their complete control over the corporate form to commit specific egregious acts is key to maintaining a balance between the guiding principles of limited shareholder liability and the fact that shareholders occasionally misuse the corporate form as a shield from liability for their own misdeeds.

The Court noted that were it to allow piercing every time a corporation under the complete control of a shareholder committed an unjust or inequitable act, virtually every closed corporation could be pierced and controlling shareholders in publicly traded corporations could also be subject to frequent piercing. Thus, the Court found the proposed expansion of the second prong of the test to include unjust or inequitable conduct too broad.

The Court, however, found it necessary to make some modification to the second prong of the test. In view of the reality that shareholders could seriously misuse the corporate form and evade personal liability under the second prong as previously worded, the Court found it necessary to modify the second prong of the test to allow for piercing in the event that egregious wrongs are committed by shareholders.

For the full opinion see: http://www.supremecourtofohio.gov/rod/docs/pdf/0/2008/2008-Ohio-4827.pdf

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