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Piercing the Corporate Veil by Joel Glick, CPA/CFF, CFE, CGMA, and Jorge L. Guerrero, CPA, CFE, CAMS

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Posted on October 30, 2024 by Joel Glick

It is well established that a legal entity created for the purpose of carrying on a trade or business is considered a separate and distinct legal entity from its owner(s) or shareholder(s). However, there are circumstances in commercial litigation when a plaintiff may pierce this corporate veil and hold the owners personally liable for the torts and liabilities of the business entity. Doing so carries a heavy burden that litigants and their counsel must overcome to build their cases on sound forensic accounting techniques.

A business structured as a traditional corporation, limited liability company (LLC) or limited liability partnership (LLP) is legally considered separate and independent from its principal owner(s), partner(s) or shareholder(s), regardless of whether they are one individual, several partners, or another corporation in the case of a parent-subsidiary relationship. This means that the business’s assets are considered separate from those of its owners, who receive a level of “limited liability” protections when conducting activities within the scope of the trade or business. In other words, owners and partners generally are not held personally liable for the corporation’s actions and debts. Yet, there are times when the courts will consider whether the owners ran the business in such a way to justify them looking behind the corporate veil, putting aside the owners’ limited liability protections and requiring owners to reach into their own pockets to satisfy the business’s debts and other obligations. This is often done through a legal theory referred to as “Alter Ego,” [1] which the courts can invoke to avoid inequitable results that might result from continuing to recognize the legal separateness of a business entity (e.g., cases where a sued business entity is rendered “judgment proof” due to having insufficient assets to pay a judgment).

Given that corporate law is governed at the state level, there is no federally agreed-upon standard for when courts will allow litigants to pierce a corporate veil. Whether a court finds a company to be an alter ego of the owners depends on each case’s various facts and circumstances.

Alter Ego

The legal doctrine of Alter Ego gives the plaintiff standing[2] to sue the owners of a business entity with which it conducted business that it ordinarily would not have standing to sue based on traditional law.

The burden of proving that a business entity is merely the instrument or “alter ego” of its owner(s) is on the moving party. Forensic accountants are uniquely positioned to aid in meeting this burden by introducing evidence on various factors, also known as “indicia.”  The following are indicia of factors the courts consider in determining whether or not to pierce the corporate veil.

Dominion and Control

Forensic accountants and CPAs’ expertise regarding corporate structures can also help establish the degree of control an owner/parent might have over the defendant entity. Control, in this context, generally refers to an owner’s/parent’s ability to affect policy and decision-making of the organization.

An analysis of articles of incorporation, operating agreements, general ledgers and financial statements can reveal how much of the defendant entity’s capital stock is owned by the owner(s)/parent(s), the degree to which the defendant conducts business with entities other than the owner(s)/parent(s), whether the defendant entity is described or depicted in the owners’/parents’ documents as a “department” or “division,” and whether the owner/parent views the defendant entity as its financial responsibility.

This type of examination can also reveal whether the assets of a defendant entity are simply those relayed to it by the owner(s)/parent(s) and whether they use those assets as their own. Such facts and circumstances further indicate that the owner/parent has dominion and control over the defendant entity.

Financial Dependence

Demonstrating that a defendant entity is financially reliant upon its owner(s)/parent(s) lends credibility to the idea that the entity and the owners are really one and the same. Some factors for consideration include whether the defendant entity is grossly undercapitalized and whether it relies on its owner(s)/parent(s) to finance operations, subsidize operating losses and pay expenses, including payroll. Additionally, an entity’s inability to obtain credit or a loan on its own accord, independent of the owner(s)/parent(s), could indicate that it is financially is financial dependent on the owner(s)/parent(s).

Arrangements such as loans, credit terms and contracts (or lack thereof) can also provide keen insights into the financial dependence of a defendant entity on its owners. For example, indicia of the economic interdependence between a defendant entity and its owner(s), which can help establish the theory of Alter Ego, include circumstances where credit terms are significantly more favorable than what would be offered to a third party, there is a lack of formal documentation or a lack of repayment.

Lack of Separateness

Another area where forensic accountants can support an Alter Ego theory is by analyzing standard corporate documents, such as Board meeting minutes, articles of incorporation, by-laws, and public record filings. These documents can reveal whether or not an entity observes its own formal legal requirements, such as holding meetings of the Board of Directors and electing officers annually, and whether it has the same directors, officers, offices, business activity, attorney, and accountants as the owner(s)/parent(s).

An analysis of contracts can also reveal whether certain related party transactions were conducted at a fair market value. If the terms or rates of the contract are more favorable than what an independent third party would offer, it could indicate a lack of separateness between the two entities. Moreover, a lack of formal written intercompany contracts between the target entity and its owner(s)/parent(s) for loans or other transfers of assets can provide further evidence that the owner(s)/parent(s) view and treat the subsidiary as if it were an extension of themselves and that the two ostensibly separate legal entities are, in reality, one and the same.

The indicia of Alter Ego described above are merely a few examples of how forensic accountants can help advance the Alter Ego legal theory in litigation and potentially assist clients in recovering for damages suffered by a company that no longer has the ability to pay. Many other facts can contribute to the narrative that a defendant entity or judgment debtor is the mere “instrumentality” or Alter Ego of an owner/parent. It is imperative that plaintiffs and their counsel connect with experienced forensic accountants who are well-versed in these types of exercises to put forth the best evidence possible.

About the Authors: Joel Glick, CPA/CFF, CFE, CGMA, is a director of Forensic and Advisory Services with Berkowitz Pollack Brant, where he serves as a litigation consultant and expert witness in a wide array of economic damages matters, forensic accounting and investigations matters, as well as insolvency and receivership matters.

Jorge L. Guerrero, CPA, CFE, CAMS, is a manager with Berkowitz Pollack Brant’s Forensic and Advisory Services practice, where he conducts forensic accounting financial investigations and economic damages analyses on matters relating to bankruptcy and receivership, breach of contract, shareholder disputes, and asset misappropriation.

They can be reached at the CPA firm’s Miami office at (305) 379-7000 or info@bpbcpa.com.

This material is being provided for information purposes only. Since neither author is an attorney, readers should construe the article as legal opinion nor should they rely on it as legal advice.

[1]  Alter Ego means “second self” or “other self” in Latin. Many of the alter ego indicia described below have a particular focus in demonstrating a business entity is the “second self” of its owners.

[2] Ordinarily, a plaintiff must show some connection to a defendant in order to have standing to sue. This may be in the form of a contract with the defendant or other duty owed to the plaintiff.