Question

Piercing the Corporate Veil

Many business owners choose corporations as their business form because they want to enjoy the limited personal liability corporate status offers. Because a corporation is considered a separate entity, shareholders enjoy limited personal liability from the debts of the corporation.

However, in some cases, courts will deny limited liability to a corporation that would normally have de jure or de facto status because shareholders have used the corporation to engage in illegal or wrongful acts. In these cases, courts pierce the corporate veil, or impose personal liability on shareholders. Courts are likely to pierce the corporate veil when:

1. A corporation lacked adequate capital when it initially formed.
2. A corporation did not follow statutory mandates regarding corporate business (e.g. hold meetings and maintain corporate records).
3. Shareholders' personal interests and corporate interests are commingled such that the corporation has no separate identity.
4. Shareholders attempt to commit fraud through a corporation.

Consider this scenario: Local farmers in Manchester, Iowa decided to build an ethanol plant. They formed Northeast Iowa Ethanol, LLC to raise additional financing to develop the ethanol plant. The project needed another $20 million. Drizin formed GSI, Inc. with $250 capital.  Drizin talked Northeast Iowa Ethanol, LLC into transferring its money to his company, GSI. Drizin commingled Northeast Iowa's funds with his own personal funds. Through an array of transfers by GSI, Northeast Iowa’s funds were stolen or put in worthless investments. Northeast Iowa sued Drizin for civil fraud to recover its funds. Drizin argued that he was shielded from personal liability because he was a shareholder.

Does the doctrine of piercing the corporate veil apply in this case, thus allowing the plaintiffs to pierce the corporate veil of GSI and reach shareholder Drizin for liability for civil fraud? What factors did you consider in reaching your decision?

Answer 1

Piercing the Corporate Veil" and Alter Ego doctrine

The term piercing the Corporate Veil, is applied in legal matters to refer to a situation where the court lifts limited liability and in the event holds the shareholders and or the directors of the Corporation personally responsible for the debts or actions of the corporation. The concept in a great sense contradicts the traditionally held frame where a Corporate is considered to be an independent legal entity with full responsibility for its debt as well as benefits accruing from credit it is owed.

Alter Ego Doctrine is defined as a principle by which a court holds every shareholder responsible for the debts of the corporation and more specifically in situations where the Corporate is considered a trustee of its owners. The Piecing the Corporate Veil principle and that of Alter ego points to the fact that the court can at times overrule legal friction depending on the uniqueness a particular situation presents. For instance in the given case, Drizin’s actions amount to the costs incurred being placed on his shoulder because he opens up GSI with the aim of defrauding Northeast Iowa despite being a shareholder of Northeast Iowa. In as much as cooperates exist as separate entities and hence with the responsibility to protect shareholder’s personal assets from being used as personal liability for actions as well as the corporate debts limits of the protection responsibility have with time been narrowed. The latter is highly applicable to close corporations with limited assets and stakeholders. In closed corporate with above characteristics, recognizing the corporate as a separate entity from its shareholders would occasion an increase in fraud related cases.

Ethics and Corporate Responsibility (accountability), The Sarbanes-Oxley Act of 2002 and Significance of Outside Independent Auditing

Ethics and corporate responsibility provide information on the stakeholders of the corporate as well as individuals tasked with the general liability of an organization. Ethical and corporate responsibility provide answers to vital decisions emanating from mid-level management, as well as information on change strategies to promote an ethical environment at workplace and strategies aimed at improving operations with a chief objective of achieving higher profits.

While an organization has to ensure every shareholder receives fair treatment, the organization has the right to initiate punishment to individual shareholders who are not accountable in their working. The corporate has a responsibility to ensure such members are held responsible for their doings and must use lawful means to get compensation. For instance, it was in the best interest of the organization to take action against Drizin for commingling the organization's funds and using them for personal benefits. It is, therefore, clear that organizations have a responsibility to enhance ethical conduct by fostering a high sense of accountability.

Sarbanes-Oxley Act of the year 2002 is a federal law of the US that established new conditions for all boards of public companies situated in the US, the management as well as all public accounting organizations. The Act has eleven sections and also provide provisions that apply to privet companies, for instance on the destruction of evidence to prevent a lawful investigation.

Among the issues addressed in the Act's section include; responsibilities and roles of organization's board or council of directors, penalties attached to particular misconducts as well as a directive to the commission tasked with Security and Exchange to establish regulations that define public corporations compliance with the law. It is important to note that Sarbanes-Oxley Act of 2002 was enacted as a response to increasing number of accounting scandals in major corporate such as Worldcom and Enron.

Independent auditing by external auditors is of great importance to corporations because it leads to a more analytical and unbiased financial reviews whose information can be relied on in explaining the accountability of the firms. An independent audit through an objective analysis helps organizations to discover scandals or unethical conduct in their auditing systems and which may have been propagated by the organization's financial officers.

Company Owners Ethical Responsibility

Business owners possess ethical responsibility which players in the company depend on for them to remain on the course of good actions. Business owners must portray a greater sense of being respectful and honest if they are to receive easily the same from the shareholders. The company owners apart from being polite and reasonable had the ethical responsibility of enhancing the satisfaction of all stakeholders' needs in a bid to prevent them from the thought of utilizing company funds in settling personal debts.

The company owners were in this sense responsible for enhancing the implementation of strategies such as communicating company's ethical expectations to all stakeholders in a bid to prevent accountability frictions within the organization. The owners of the Company were also expected to portray higher moral standards to positively influence the stakeholders. The owners could also stick to using an account where they are part of the signatories as opposed to an escrow account which gave Drizin total control of the finances of the company.