Piercing the Corporate Veil: Now or Later?
April 7, 2017
By Dana W. Chilson
You bring a lawsuit against a corporation, and you win. Eagerly anticipating your deserved payout, you receive concerning news – the corporation has insufficient funds to pay you. Certainly you have the right to be paid. What do you do now?
Business corporations are structured as separate legal entities to ensure that, under most circumstances, directors, officers, shareholders, and parent companies are shielded from liability. Some companies, however, are merely shells and exist to protect the assets of another entity. This leaves a judgment holder in a bad spot; the judgment is against the company, but the company has no assets to pay the judgment because those assets are held elsewhere. To solve this issue, a plaintiff can seek to pierce the corporate veil and hold directors, officers, shareholders, or parent companies directly liable for the corporation’s judgment.
Plaintiffs can must consider pursuing veil piercing at the outset of litigation by pleading an “alter ego” theory in the initial complaint. Under this theory, a plaintiff must demonstrate that a director, officer, shareholder, or parent company extends such power and control over the corporation that the two are functionally the same entity. Courts will consider multiple factors in determining when to pierce the veil, including: (1) gross undercapitalization of the corporation; (2) failure to observe corporate formalities; (3) substantial commingling of corporate and personal affairs; and (4) use of the corporate form to perpetuate a fraud. Pennsylvania courts, however, are extremely reluctant to go down this road. Because of that, a plaintiff must have relevantly strong evidence to prevail on a veil-piercing theory.
An alternative method exists for a plaintiff who may not be able to overcome such a high burden at the outset of litigation: piercing the corporate veil through post-judgment garnishment actions. Garnishment is the process of retrieving a debtor’s assets from a third party. Due process concerns arise, however, when a party is held accountable for a judgment in a case in which it had no chance to defend itself. As a result, a plaintiff attempting to pierce the corporate veil through a post-judgment garnishment action faces additional procedural hurdles.
First, the plaintiff must submit an affidavit establishing facts which clearly demonstrate that the garnishment defendants are alter egos of the judgment debtors. This affidavit must be presented to the court, which will then issue a writ of execution to proceed with the garnishment if there is probable cause to do so. Second, the plaintiff must post a bond to indemnify the company in the event there is an inappropriate acquisition of assets. Finally, the plaintiff must prove the existence of an alter ego relationship at an immediate post-attachment hearing. Despite the additional procedural requirements, this method is beneficial to a plaintiff who needs post-judgment discovery on assets to make an adequate case for corporate veil piercing. Such discovery is not available prior to obtaining a judgment.
While piercing the corporate veil is difficult regardless of the timing, knowing the strategic advantages of veil piercing at the pre-judgment stage versus the post-judgment stage could increase a plaintiff’s probability of collecting its judgment.
The author extends special thanks to Sarah Dotzel, who assisted in preparing this article.