A key reason a business entity (such as a corporation or LLC) is formed is to limit the personal liability of the entity’s owners and operators. “Piercing the corporate veil” is when the court disregards the entity shell and holds the owners/operators personally liable for the entity’s debts and obligations. In Pennsylvania, there has always been a strong presumption against piercing the corporate veil. However, there are three theories under Pennsylvania law that may be used to hold business owners and operators personally liable.
‘ALTER EGO THEORY’
The first and most common is the “alter ego theory.” The factors involved in the alter ego theory include: gross undercapitalization, substantial intermingling of corporate and owner affairs, failure to adhere to corporate formalities, and use for fraud.
Gross undercapitalization occurs when there is insufficient capital consistently and thus a deliberate failure to meet an entity’s obligations. This factor typically occurs in conjunction with the intermingling of corporate and owner affairs (i.e. the owner uses corporate accounts as his personal checking account or vice versa). If personal expenses are routinely being charged to corporate accounts, then a court is more likely to find the entity is an extension of the owner (i.e. an alter ego), which invites a finding of personal liability.
Another common factor of an alter ego argument is failure to adhere to corporate formalities. Examples include failing to: conduct shareholder and board of director meetings, open a separate corporate bank account, or perform services without appropriate corporate resolutions.
A third factor is a finding that the entity is being used to benefit the owners at the expense of others. This means that the owners are intentionally utilizing one of the other factors of the alter ego theory in order to limit the amount that the plaintiff may recover if successful. Usually a single factor is not enough to persuade a Court to pierce the corporate veil. However, it is important that all requirements are followed in order to ensure that the liability remains with the entity and not the owners.
‘PARTICIPATION THEORY’
The second theory in which a plaintiff may pierce the corporate veil is the “participation theory.” This theory is applied to the owners or officers which engage in the activity that causes the liability. Because the owner has engaged in the activity, which may be lawful, they are still found liable if the activity results in damages. The corporate structure does not protect them from liability when it is their own personal actions that caused the damage.
‘ENTERPRISE THEORY’
The “enterprise theory” is the third and final theory in which the corporate veil can be pierced and is relatively new in its application in Pennsylvania. The enterprise theory, otherwise known as horizontal veil piercing, occurs between parent and subsidiary or brother and sister companies within a corporate structure. Utilization of the enterprise theory will be successful based on the following factors: identity of ownership, unified administrative control, similar or supplementary business functions, involuntary creditors, and insolvency of the corporation against which the claim lies. If it is found that multiple entities are under common control (same owners) and operate a single or related business enterprise, then the liability can be extended from one entity to another to allow a plaintiff access to more assets for damages if the assets of the initial entity are insufficient. This theory is not favored by Pennsylvania courts, but it has been sufficiently pled in a few cases to be a cause for concern.
When attempting to limit liability it is important to remember that it is not enough to create a separate entity, you must act as though the entities or owners are separate and distinct from each other. Failure to do so can defeat the purpose of creating an entity in the first place.
For more information, contact MacDonald Illig Attorneys at 814/870-7600 or visit macdonaldillig.com.
Kyle E. Gallo is an associate at MacDonald Illig Attorneys. He is a member of the Firm’s Trusts & Estates and Business Transactions Practice Groups.
Emilie S. Reinhardt is an associate at MacDonald Illig Attorneys. She is a member of the Firm’s Trusts & Estates and Business Transactions Practice Groups. She earned a Bachelor of Arts Degree in Legal Studies from Gannon University and her Juris Doctorate from Duquesne University.
