Chapter 4 Piercing the Corporate Veil
• 1. Problem generally:
One of key attributes is limited liability. In a few
very extreme cases, courts may “pierce the
corporate veil,” and hold shareholders personally
liable for the corporation’s debts.
• 2. Individual shareholders
• 3. Parent/subsidiary
• 4. Brother/sister
Provisions of Chinese Company Law
• Art. 3 The liability of a shareholder of a
limited liability company shall be limited to
the amount of its capital contribution.
• Art. 20 Shareholders of a company who
abuse the independent legal person status
of the company and limited liability of
shareholders to evade debts and cause
damage to the interests of the creditors of
the company shall bear joint liability for the
company’s debt.
Factors considered in terms of
the Individual shareholders
• The followings are some factors that courts look to in
deciding whether to pierce the corporate veil:
• 1. Tort (involuntary) vs. contract (voluntary)
• 2. Fraud or wrongdoing
• 3. Inadequate capitalization
•
a. Zero capital
•
b. Siphoning
• 4. Failure of formalities
• In nearly all cases, at least two of the above four factors must
be present for the court to pierce the veil. The most common
combination is inadequate capitalization plus the last one.
Tort claims vs. contract claims (“voluntary
creditor” doctrine)
• Scenario 1: A Sale
Delivery Corp.
•
mini computer
• On credit balance sheet net worth
•
Dennis (Sole shareholder)
• Scenario 2: Peter
•
•
Delivery Corp.
hit by the van
Dennis (Sole shareholder)
• Factors: Can or can not bargain for a personal guarantee?
•
Voluntarily or involuntarily to become a creditors?
Fraud of wrongdoing
• Fraud or wrongdoing by the shareholders
refers to some means by which controlling
shareholders siphoned out its assets or
make misrepresentation to shareholders.
• A. Siphons out: Draws a salary that
changes from month to month.
• B. Misrepresentation: knowingly and falsely
tells creditor that corporation has one million
dollars in its bank account.
Inadequate Capital
• Q: whether grossly inadequate initial
capitalization, by itself, will suffice to
pierce the corporate veil?
• Case: D owns ten corporations, each of which
owns two cabs. Each cab is insured for the
statutorily-required minimum amount of $10,000. P is
severely injured by a cab owned by one of D’s ten
corporations, then sues to hold D personally liable,
and to hold other nine corporations jointly liable.
Inadequate Capital
• Not usually dispositive:
• 1. Minority view: absolutely affirmative
• 2. Majority view: require either some
affirmative fraud or wrongdoing by the
shareholder, or a gross failure to follow
the formalities of corporate existence.
Inadequate Capital
• The situations of inadequate capital
• 1. Zero capital:
•
Case: P
Industrial Realty Co.
•
sub-lease
•
Polan Industries
D
• Other than this lease, Industrial has no assets,
no income and no bank account.
• When nothing is invested in the corporation, the
corporation provides no protection to its owner; nothing
in, nothing out, no protection.
Inadequate Capital
• 2. Siphoning of profits:
• Drains out all of the profits and/or capital
whether in the form of salaries, dividends,
loans to himself, or whatever.
• Example: A
B
•
•
•
C
D
E
Controlling Shareholder
Inadequate Capital
• 3. Failure to add new capital
• The corporation at the time it is set up
has adequate capitalization.
• Due to facts not evident at the time of
incorporation, the business’ capital
diminishes.
• Q: Should shareholders are required to
replenish the capital?
Inadequate Capital
• 4. Business grows
The initial capitalization is adequate, but the
business grows to the point where capital that
was once adequate is no longer adequate to
meet the new likely responsibilities.
Q: Should it be considered “inadequate
capitalization” of the sort that should make
veil-piercing more likely?
Failure to follow corporate formalities
• A. illustrations:
• a. Shares are never formally issued, or
consideration for them is never received by
the corporation;
• b. shareholders’ meetings and directors’
meeting are not held;
• c. shareholders do not sharply distinguish
between corporate property and personal
property.
• d. proper corporate financial records are
not maintained.
Failure to follow corporate formalities
• B. Injury to creditor: actual injuries
to creditors.
• a. Commingling of legal personalities:
taking of cash from the corporation’s bank
account to pay personal debts.
• b. Misleading to creditor: putting his
personal name on the business door instead
of the corporate name, or paying some of its
bills with a personal check.
Failure to follow corporate formalities
• C. No injury: In most reported cases where
the court pierces the veil, the failure did not
injure the creditors.
• a. Possible explanation: shareholder not
permitted fist to ignore the rules and then
later to claim the advantage to the corporate
shield.
• b. Alternative explanation: at least suggest
fraudulent transfers may have taken place.
Parent/subsidiary
• 1. Greater tendency to pierce
•
• 2. General rule of non-liability:
A. Illustration: (1) corporate formalities are observed;
(2)the public is not confused; (3)the subsidiary is
operated in a fair manner; and (4)no other manifest
unfairness.
• B. Case:
Parent/subsidiary
• 3. Factors leading to veil-piercing
• a. Intertwined operations
• b. Unified business and subsidiary
undercapitalized:
• c. Misleading to public:
• d. Intermingling of assets
• e. Unfair manner of operation
Brother/sister corporations
• Structure: A single corporate parent and multiple
corporate subsidiaries or “children”.
• Case:
A1
A2
•
Parent company A3
A4
A5
Implications: single name advertised in the Yellow
Pages, a single phone number, a single dispatch
office, a single repair operation, etc.
Result: be viewed as a single integrated business
enterprise.
Distinction between active and passive investors
• Implication: The courts is far more likely to pierce
the corporate veil to the detriment of an active
investor than to the detriment of a passive one.
• Case: One company consisting of two shareholders,
each owning 50% of corporation. Active runs the
company from day to day. Passive’s involvement is
limited to supplying initial capital. Active commingles
his personal funds with those of corporation, fails to
see to it that board meetings are held, and misleads
creditors into thinking that he is a sole proprietor.
Insider Claims in Bankruptcy
• Generally: Rules would apply when a
corporation becomes bankrupt, and
shareholders turn out to be creditors.
• Disallowance of claims:
• (1) Payment for services: disallow his claim
for the unpaid portion of excessive salary.
• (2) Transforming loan into capital: Where the
stated capital is very clearly inadequate for
the corporation’s expected business.
Insider Claims in Bankruptcy
• Equitable subordination
• 1.Implication: Insiders’ claim be satisfied only after
all other creditors have been fully satisfied.
• 2.Grounds: There is no cut-and-dry test for
determining when equitable subordination should be
applied. The same rules of piercing the corporate
veil apply.
• 3.“Deep Rock” doctrine: named after a subsidiary in
a famous case. A parent’s claim against subsidiary
is barred.
• 4. Less wrongdoing required:
Chapter 4: One-person Limited Liability Companies
1.Definition: One single shareholder:natural or judicial?
2. Registered Capital Requirement: stricter or looser?
3. Restrictions on the Establishment of LLC
4. Identification Requirements
5. Special Requirements on Corporate Governance
6. Individual and joint liability
Definition
• Article 58
• The term "one-person limited liability
company" as mentioned in this Law refers to a
limited liability company with only one natural
person shareholder or a juridical person
shareholder.
Registered Capital
• Article 59
• The minimum registered capital of one-person limited
liability companies shall be RMB100,000. The
shareholders shall make a one-off capital contribution
in accordance with the provisions of the articles of
association of the company.
Restrictions on the Establishment of LLC
• Article 59 (Section two)
• One natural person is allowed to establish
merely one one-person limited liability
company which shall not set up any further
one-person limited liability company.
Identification Requirements
• Article 60
• A one-person limited liability company shall,
in the company registration, give a clear
indication that it is solely-funded by one
natural person or one juridical person, and
the same shall be specified in the business
license of the company.
Special Requirements on Corporate Governance
• Article 61
• The articles of association of a one-person limited liability company
shall be formulated by the shareholder.
•
Article 62
• A one-person limited liability company is not required to establish
the board of directors. When the shareholders make a decision on
any of the matters as listed in Article 38 of this Law, they shall make
it in written form, and preserve it in the company after signed by the
shareholders
Individual and Joint Liabilities
• Article 64
If the shareholder of a one-person limited liability
company is unable to prove that the property of the
one-person limited liability company is independent
from his own property, he shall bear joint liabilities for
the debts of the company.