Misconceptions About Shareholder Liability
Corporations are widely understood to be “shields” against liability for shareholders. Shareholders own stock in a corporation that owns a business, but shareholders do not own the business itself. Therefore, penalties incurred by the business should not affect shareholders because they are not technically business owners. While it is true that stock owners are not typically liable for corporate debt, there are situations where liability falls on the shareholder.
Piercing The Corporate Veil
The concept of a corporate veil is that actions taken by a corporation are separate from the actions of its shareholders. The corporate veil is a divider that insulates shareholders from the penalties for corporate misdeeds. When the courts deem a corporation guilty of crimes such as fraud, noncompliance with government programs or manipulating bankruptcy laws, they take actions referred to as piercing the corporate veil. This means they are no longer treating the business as a corporation in spite of its legally established structure. For shareholders, this means they can be held accountable for the misdeeds of the business. The government and creditors gain the right to seize assets from shareholders to pay corporate debt.
Three of the most common reasons the court pierces the corporate veil:
- Fraud – Fraud is the most common reason the court decides to pierce the corporate veil. This often involves transferring assets outside of the corporation or shutting down the business to avoid paying debt.
- Operating multiple companies under one management structure – Failure to maintain separate identities is often revealed when records show multiple companies operating from the same business address with the same officers.
- Failing to follow corporate formalities – This is a big red flag to the courts. Failing to maintain records and hold annual meetings are two of the more egregious violations that get the attention of the courts.