Piercing the Corporate Veil

By way of introduction, the owners of a corporation (shareholders) are generally not personally liable for the obligations of the corporation. Likewise, the officers and the directors of the corporation are not generally personally liable. Instead, the corporation itself will generally face liability; the owners generally risk only the investment that they made in the business when they purchased their ownership interest (equity securities, etc).

How exactly is the corporate veil pierced and what does that even mean? In a basic sense, piercing the veil means that a court will disregard a corporate entity and hold individuals (rather than the corporation) liable for corporate obligations. Generally, it's the corporation's creditors who may be allowed to pierce the veil. The bar exam will require an understanding of the three ways in which that veil can be pierced:

Ignoring Corporate Formalities: A corporation might ignore required corporate formalities to such an extent that the corporation is merely the "alter ego" of the individual shareholders. If in doing so a basic injustice results, the corporate veil might be pierced and individual shareholder liability might result. Look out for situations where shareholders treat corporate assets as their own or where shareholders simply fail to observe corporate formalities. 

Inadequate Capitalization: The corporate veil might be pierced where the corporation is inadequately capitalized such that at the time that the corporation was formed, there was not enough unencumbered capital to reasonably cover prospective liabilities. 

Fraud & Avoidance of Personal Obligations: If necessary to prevent fraud or to prevent an individual shareholder from using the corporate entity to avoid existing personal obligations, the corporate veil might be pierced. Might be noted that the mere fact that an individual has formed a corporation to avoid future personal liability is not itself a reason to pierce the veil. In fact, that's a common motivation for adopting the corporate form.

Let's assume now that the veil is pierced. If so, generally the shareholders who are active in the operation of the business will be personally liable (joint and several liability). The corporate veil is often pierced in tort cases but quite infrequently in contract cases. This is because in contract cases, parties who contracted with the corporation had an opportunity to investigate the corporation's stability. Because there was that opportunity, parties in contract cases are not likely to have the benefit of piercing the veil and will instead have to collect directly from the corporation rather than from any individual shareholder.