This article by Lin Law LLC’s Attorney Emily E. Ames was featured in the August 3, 2020 issue of The Business News.
One of the primary reasons that businesses choose to organize as a separate legal entity, in the form of either a business corporation or limited liability company (LLC), is so that their shareholders, directors, and officers are shielded from personal liability for claims against the business. This concept is often referred to as “limited liability” or the “corporate veil.”
The veil, however, it not absolute. Under certain circumstances, the corporate veil may be pierced, or disregarded, by a court in order to hold the corporation’s shareholders, directors, or officers (or, in the case of an LLC, its members or managers) personally liable for claims against the business. This can include liability for unsatisfied debts and contractual claims.
The primary test for piercing the veil is the “alter ego” doctrine. This refers to a situation where an individual shareholder, director, or officer has essentially utilized the corporate entity as his or her alter ego. Unlike that of a comic book superhero, however, this alter ego is used not for good, but personal gain.
Under Wisconsin law, invoking the alter-ego doctrine in order to pierce the corporate veil requires a plaintiff to meet all three of the following elements:
1. The individual shareholder, director, or officer controlled the business with respect to a particular transaction, such that the corporation had no separate mind, will, or existence of its own
2. The individual shareholder, director, or officer used his or her control of the business to commit a fraud or wrong, to violation a statutory or other legal duty, or to act dishonestly or unjustly; and
3. There was a causal connection between the first two elements and the plaintiff’s injury.
In other words, a court will pierce the corporate veil and hold an individual shareholder, director, or officer personally liable where he or she inappropriately utilized the corporate entity for his or her own personal gain, whether monetary or otherwise.
In evaluating the first element, courts will consider whether corporate formalities have been observed. These includes holding regular corporate meetings, maintaining all necessary corporate records, and segregating corporate assets from those of its shareholders. The second element often considers whether the corporate entity was adequately funded at inception or when a particular transaction took place. Under-capitalization can serve as evidence that the entity was created solely for purposes of shielding the shareholders’ personal assets. Finally, the first two elements must have actually caused or contributed to the plaintiff’s injury.
It’s important to note that piercing the veil is generally unnecessary to hold individual shareholders, directors, and officers personally liable for their own tortious conduct, even if the conduct was committed in the scope of the individual’s employment. The corporate veil may also be disregarded where the corporation has violated consumer protection laws promulgated by the Wisconsin Department of Agriculture, Trade and Consumer Protection, or in situations where piercing the veil is supported by a compelling public policy rationale.
So how does a closely-held corporation or single-member LLC maintain the limited liability? The primary line of defense is maintaining appropriate corporate formalities. For a business corporation, this means holding annual meetings and preparing minutes. At a minimum, the annual minutes should document the election of officers and directors and ratify any significant actions taken on the corporation’s behalf. An LLC must maintain its own bank accounts and records, and its members should ensure to conduct business only in the name of the LLC. While annual meetings are not statutorily required, significant transactions should be approved by the members in writing.
Limited liability is one of the primary benefits afforded to businesses incorporated or organized under Wisconsin law, but only if it is respected and maintained accordingly.