Why Courts Pierce: An Empirical Study of Piercing the Corporate Veil

Abstract

Limited liability of business owners for 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 business owner's potential personal loss is fixed amount, namely, amount invested in business, usually in form of stock ownership. Consequently, if business succeeds, owner obtains profits, but if business fails, all of losses beyond 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 very beginning, relieving business owners of liability for operations of business has had proponents and detractors. In 1800s, Thomas Cooper described corporate limited liability as mode of swindling, quite common and honourable in these United States and a fraud on honest and confiding part of public. In rhetorical counterpoint, President Nicholas Butler of Columbia University proclaimed limited liability as the greatest single discovery of modern times, and that steam and electricity are far less important than limited liability corporation, and they would be reduced to comparative impotence without it. The academic debate over propriety of limited liability continues unabated. This ambivalence over propriety of limited business liability is reflected in courts in form of veil piercing. Piercing corporate veil is common law legal doctrine used to break rules of traditional limited liability for owners, and to hold shareholders accountable as though corporation's action was shareholders' own. In deciding whether to pierce veil, courts look to sometimes disparate factors and often use unhelpful, conclusory characterizations such as alter ego and instrumentality to describe relationship between shareholders and corporation. While corporate veil is 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 first to empirically examine distinct question of substantive common law piercing of corporate veil. As matter of pure hypothesis, one would expect that any common law doctrine should be applied by courts in neutral manner, that is, evenhandedly except for variations in factors explicitly and specifically identified as part of applicable test. Given that presumption, empirical results of this study, even on descriptive level, are startling. Among 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 corporate veil. Courts are more likely to pierce to enforce contract claim than to award recovery to tort claimant The kitchen-sink' approach to piercing litigation (adding as many possible substantive claims as possible) is not as effective as bringing single claim. More fundamentally, this Article is first to apply to substantive piercing advanced statistical techniques of quantitative analysis.This study has produced number of key findings brought to light only through implementation of logistic regression methodology. Among these findings are: Pure descriptive statistics indicate that relationship between plaintiff type (i.e. individual or entity) and claim type (tort, contract, etc.) is statistically significant, as are 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 statistically significant effect on piercing. However, this does not prove to be true when these hypotheses are tested in 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 strongest and most predictive relationship with piercing corporate veil. Indeed, presence or absence of these factors alone is usually dispositive of piercing decision. Conversely, factors reflecting lack of operational formalities, such as non-existence or non-functioning of corporate directors or officers, are not significantly related to piercing in regression models. While only discussed in 3% of cases, assumption of risk has large impact on incidence of piercing corporate veil. It is only factor that applies to plaintiffs, and when court finds it present likelihood of pierce is drastically reduced.