Why Courts Pierce: An Empirical Study of Piercing the Corporate Veil
71 Pages Posted: 26 Jun 2011 Last revised: 8 Jul 2011
Date Written: January 1, 2010
Limited liability of business owners for the contracts, torts and other liabilities of their companies has been commonplace for over one hundred and fifty years. This concept of limited liability means that a business owner's potential personal loss is a fixed amount, namely, the amount invested in the business, usually in the form of stock ownership. Consequently, if the business succeeds, the owner obtains the profits, but if the business fails, all of the losses beyond the owner's fixed investment are absorbed by others, that is, voluntary or involuntary creditors, or society at large. Although initially applicable primarily to corporations, new forms of business organizations have appeared, such as limited liability partnerships and limited liability companies, which also offer limited liability to their owners.
Although limited liability for business owners is common, it is not uncontroverted. From the very beginning, relieving business owners of liability for the operations of the business has had proponents and detractors. In the 1800s, Thomas Cooper described corporate limited liability as a "mode of swindling, quite common and honourable in these United States" and "a fraud on the honest and confiding part of the public." In rhetorical counterpoint, President Nicholas Butler of Columbia University proclaimed limited liability as "the greatest single discovery of modern times," and that "even steam and electricity are far less important than the limited liability corporation, and they would be reduced to comparative impotence without it." The academic debate over the propriety of limited liability continues unabated.
This ambivalence over the propriety of limited business liability is reflected in the courts in the form of veil piercing. Piercing the corporate veil is a common law legal doctrine used to break rules of traditional limited liability for owners, and to hold shareholders accountable as though the corporation's action was the shareholders' own. In deciding whether to pierce the veil, courts look to sometimes disparate factors and often use unhelpful, conclusory characterizations such as "alter ego" and "instrumentality" to describe the relationship between the shareholders and the corporation. While "piercing the corporate veil is the most litigated issue in corporate law," common law piercing is complex, inconsistently applied and often poorly understood.
The empirical project presented by this Article is unique. This study is the first to empirically examine the distinct question of substantive common law piercing of the corporate veil. As a matter of pure hypothesis, one would expect that any common law doctrine should be applied by the courts in a neutral manner, that is, evenhandedly except for variations in factors explicitly and specifically identified as part of the applicable test. Given that presumption, the empirical results of this study, even on a descriptive level, are startling. Among the statistically significant findings are:
Courts pierce twice as often to hold individual persons liable than they do to hold entities, such as corporations and limited liability companies (parent-subsidiary piercing), liable.
Entity plaintiffs are almost twice as likely as individual plaintiffs to successfully pierce the corporate veil.
Courts are more likely to pierce to enforce a contract claim than to award recovery to a tort claimant
The "kitchen-sink' approach to piercing litigation (adding as many possible substantive claims as possible) is not as effective as bringing a single claim.
More fundamentally, this Article is the first to apply to substantive piercing the advanced statistical techniques of quantitative analysis.This study has produced a number of key findings brought to light only through the implementation of logistic regression methodology. Among these findings are:
Pure descriptive statistics indicate that the relationship between plaintiff type (i.e. individual or entity) and claim type (tort, contract, etc.) is statistically significant, as are the relationships separately between plaintiff type and piercing and between claim type and piercing. This would suggest that either claim type or plaintiff type, or both, would have a statistically significant effect on piercing. However, this does not prove to be true when these hypotheses are tested in the regression models. That is, even though these descriptive statistics tell us when courts pierce, they do not explain why courts pierce.
Fraud, owner control, and commingling of funds have the strongest and most predictive relationship with piercing the corporate veil. Indeed, the presence or absence of these factors alone is usually dispositive of the piercing decision.
Conversely, factors reflecting the lack of operational formalities, such as non-existence or non-functioning of corporate directors or officers, are not significantly related to piercing in the regression models.
While only discussed in 3% of cases, assumption of the risk has a large impact on incidence of piercing the corporate veil. It is the only factor that applies to plaintiffs, and when a court finds it present the likelihood of a pierce is drastically reduced.
Keywords: Empirical, Pierce
Suggested Citation: Suggested Citation