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Will your corporation protect
you?
By Kent Hanszen
Board Certified - Civil Trial Law,
Texas Board of Legal Specialization
Many business owners operate under a corporation, in large part, to protect their personal assets. A corporation is given special legal status as a separate legal entity from its shareholders, officers and directors, and the corporate form normally insulates shareholders, officers and directors from liability for corporate obligations. In fact, courts have noted that a corporation�s separateness exists for the very purpose of escaping personal liability. But, if individuals abuse the corporate privilege, courts will disregard the corporate form, or �pierce the corporate veil,� holding owners, directors, or officers individually liable.
Generally, Texas courts are reluctant to pierce the corporate veil except in drastic circumstances, recognizing the need to protect the �corporate fiction� under which much business is done. Yet, despite a stated willingness to recognize the separate existence of corporations, the courts in recent years have managed to alarm both the business community and the legislature by their application of veil-piercing doctrines. The courts have identified a wide variety of corporate behavior which may justify piercing, including failure to observe corporate formalities, inadequate capitalization of the company, commingling corporate assets with personal assets, use or payment of employees by owner, diversion of funds and lack of arms-length transactions between owner and corporation. Notwithstanding these examples, the corporate form will be disregarded, usually, in one of two instances: if a corporation is used for an improper purpose, such as fraud, or if the corporation is the �alter ego� of its owners (i.e. the owners exercise such control over a corporation that the entity has no separate existence, e.g. the corporation is used as the owners� own personal piggy bank).
When a corporation is used to perpetrate a fraud.
The corporate form may be disregarded when a corporation is used as a means of perpetrating a fraud. The Texas Supreme Court has held that, to prove there has been a sham to perpetrate a fraud one may show constructive fraud, rather than or in addition to actual fraud. Actual fraud is what usually comes to mind when �fraud� is raised, and it involves dishonesty of purpose or intent to deceive. Constructive fraud, in contrast, is the breach of some legal or equitable duty which, irrespective of moral guilt, the law declares fraudulent because of its tendency to deceive others, to violate confidence or to injure public interests.
While the number of possible shams is probably infinite, the Texas Supreme Court identified the following common scenario: a closely held corporation owes unwanted debts; it siphons off corporate revenues, sells off much of the corporate assets or does other acts to hinder the ongoing business and its ability to pay its debts; a new business then starts up that is basically a continuation of the old business with many of the same shareholders, officers and directors.
And while the above standard seems to apply in tort actions, the legislature has imposed more stringent standards in contract actions. In cases grounded on a contractual obligation of the corporation, actual fraud must be established before the corporate veil may be pierced.
When the corporation is used as an �alter ego.�
Alter ego is shown from the total dealings of the corporation and the individual. However, various factors are taken into account in these cases.
These factors traditionally have
included: (1) the degree to which corporate formalities have been followed;
(2) the degree to which corporate property and individual property have been kept separate;
(3) the amount of financial interest, ownership and control the individual maintains over the corporation; and
(4) whether the corporation has been used for personal purposes. The legislature has eliminated mere disregard of formalities as a basis for the establishment of alter ego liability.
A few minor instances of confusion between an entity and an individual will not establish an alter ego relationship, as a matter of law. For instance, the fact that a person sometimes identifies himself or herself as the president of a corporation, but in other instances as a sole proprietor, does not create a fact issue on alter ego.
In summary, corporations are considered separate entities under the law. But, when people do bad things expecting the corporation to protect them, normal corporate separateness is sometimes disregarded, or pierced. If this occurs, the owners, directors or officers (and even others in a corporation) may be held personally liable for the corporation�s actions. The corporate form may also be ignored if owners do not maintain the corporate formalities and maintain separateness between themselves and the corporation.
Kent Hanszen, (713) 522-9444, [email protected]
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