Limited Liability Doctrine - Case Study Example

"There are no rules, other than the principles of fairness and justice, to dictate when the court should lift the veil of corporation, rendering therefore the parent company liable for the debts of the subsidiaries." In this period of recession which is experiences in all parts of the world, many are inclined in going into business. The most utilized form of business is corporation.1 Many successful and well-known business companies come in this form like Microsoft, Nokia, and Friendster. They are in fact corporations. One point being considered is that forming a corporation is moderate in terms of burden and cost since there are usually more people who share in the capital and who join hands in running the business. These people are called "owners", composed of the incorporators, directors, and the stockholders. Another point to consider is that a corporation, once approved, has a legal personality separate and distinct from its owners. Having a legal personality separate and distinct from its owners gives the corporation a limited liability to shareholders. Limited liability is a legal doctrine which means that if a "plaintiff wins a court judgment against the corporation, he (the plaintiff) cannot satisfy the judgment out of the personal assets of the owners, rather, the plaintiff must collect from the assets of the corporation".2 Limited liability is likened to a "veil" that offers the owners of the business protection for their personal assets, like for instance, if one of the co-owners or employees commits an unlawful action that injures someone, or if someone sues the corporation for non-payment of debt.3 But is the limited liability doctrine absolute The answer is it is not.4 The corporate law protection of limited liability can be lost through 1) piercing of the corporate veil, 2) defective incorporation, 3) improper signing of documents.5 This essay aims to discuss piercing the corporate veil by first explaining the limited liability rule followed by a discussion on the instances where the court can lift the corporate veil. The corporate law of piercing (or lifting) the corporate veil describes a legal decision where a shareholder or director of a corporation is held liable for the debts r liabilities of the corporation despite the principle are immune from suits in contract or tort that otherwise would only hold the corporation. This doctrine is used when the property or assets of the corporation is not enough to support its liabilities.6 "The phrase relies on the metaphor of the 'veil' that represents the veneer of formalities and dignities that protect a corporation, which can be disregarded at will when the situation warrants looking beyond the 'legal fiction' of a corporate person to the reality of other persons or entities who would otherwise be protected by he corporate fiction."7 The formation of this doctrine can be traced beginning from a number of cases formulating the law formulating the law principle of separate and distinct legal personality of corporations. This principle of English law company was firs laid down in the case of Salomon v. Salomon.8 Mr. Salomon formed a company by apportioning one share for each of his family members to comply with the statute at that time which required at least seven members to form a company. Mr. Salomon later became a secured creditor of the company. When the company fell on hard times, it paid Mr. Salomon's debenture. The unsecured creditors claimed all the remaining assets of the company arguing that it worked as an agent for Mr. Solomon. The Court held otherwise. The effect of this rule is that the individual subsidiaries with in a conglomerate will be treated as separate entities and the parent cannot be made liable for the subsidiaries' debts or insolvency.9 Attempts to lift the principle of separate and distinct legal personality of corporations were unsuccessful in a number of cases that followed after the establishment of the said principle. For instance, in Adams v. Cape10 , it was held that the corporate veil cannot be lifted merely because justice requires it.11 It can only be lifted in the following circumstances: a) where the court is construing a statute contract, or other documents which requires the veil to be lifted; b) when the court is satisfied that the company is a "mere faade", so that there is abuse of corporate form, and c) when it can be established that the company is an authorized agent of its controllers or its members, corporate or human. Cape was an English company with two subsidiaries which were based in the US and in the UK. When the company started closing down its business in the US to concentrate in the UK, a group of people sued Cape and its subsidiaries. In deciding the case, the Court provided and followed the afore-mentioned circumstances, decided in favor of Cape. The decision was based on a number of circumstances like the absence of legal documents or statutes stating that the veil should be lifted and to prove that there was an agency relationship between Cape, the parent company, and its subsidiaries. In the case of Edwards Company, Inc. v. Monogram Industries, Inc., Monogram Industries, Inc.12 acquired Entronic Corporation, a company that produced smoke detectors. Monogram made the puchase through a wholly-owned subsidiary called Monotronics, itself a corporation. Monogram owned 100% of Monotronics' stock. Monotronics then formed the Entronic Company, a limited partnership in which Monotronics was the only general partner. All went well until 1978 when General Electric began dumping smoke detectors on the market. A company called Edwards had extended about $350,000 of trade credit to Entronic, which Entronic was unable to pay, resulting in the liability of the general partner Monotronics. However, Monotronics had only about $10,000 in total assets at the time, so Edwards sued Monogram Industries to recover the debt, attempting to pierce the corporate veil of Monotronics. Edwards claimed that Monotronics had the same board of directors, same office, same payroll, and the same telephone as Monogram Industries, and therefore Monotronics was simply a piece of paper in Monogram's file cabinet. The court ruled that Edwards could not pierce the corporate veil. Monogram was not liable for the debt of Monotronics. In this case, the court described a very clear test to determine whether one can pierce the corporate veil. In order to pierce the corporate veil in contract cases, both of the following must be shown: a) there must be fraud or injustice, and, b) there must be a lack of separate existence.13 The court found no evidence of either of these. There was no evidence of not abiding by corporate formalities, no evidence of co-mingling of money (alter ego claim), and no evidence of under-capitalization. Edwards had not performed adequate due diligence. It used outdated Dun and Bradstreet reports in its research and did not really understand which entity it was doing business with.14 Following the dictum in the first two cases mentioned above, it can be said that there is no specific law that dictates the court when it should lift the veil of incorporation and render the paent company liable for the debts of its subsidiaries. Only in cases wherein the principle of fairness and justice where courts grant the piercing of corporate veil. There are factors being considered by courts in veil piercing disputes that vary from case to case. However, a representative case can be found in Sabine Towing and Transpo. Co. v. Merit Venture, Inc.15, where the Court identified several factors which alone or combination might warrant piercing the veil of corporate subsidiary to impose liability upon a parent corporation. "The factors mentioned, most of which would apply equally where liability is sought to be imposed on an individual shareholder, were: common or overlapping shareholders, directors or officers, use of same corporate office, inadequate capitalization, financing of subsidiary by parent, corporate structure in which parent exists solely as holding company for subsidiary, use of subsidiary's corporate assets by parent corporation, informal inter-corporate loan transactions, incorporation of subsidiary caused by parent, filing of consolidated income tax returns by parent and subsidiary, control of subsidiary's decision making by parent and principals, actions by subsidiary's directors contrary to subsidiary's interest and interest of parent, contracts between parent and subsidiary that are more favorable to parent, non-observance of formal legal requirements, existence of fraud, and wrongdoing or injustice to third parties."16 To conclude, therefore, it is hereby affirmed that "there are no rules, other than the principles of fairness and justice, to dictate when the court should lift the veil of corporation, rendering therefore the parent company liable for the debts of the subsidiaries" as the title of this essay suggests. As stated in a landmark case decided by the Pennsylvania Superior Court over twenty years ago, "there appears to be no clear test or well settled rule either in Pennsylvania or in the country at large as to exactly when the corporate veil can be pierced and when it may not be pierced."17 Bibliography: "Corporation". Retrieved on March 7, 2009 from "Limited Liability". Retrieved on March 7, 2009 from "Piecing the corporate veil". Retrieved on March 7, 2009 from "Protect your Corporate Veil". Retrieved on March 7, 2009 from "Piercing the Corporate Veil - Breakdowns in Limited Liability Protection in PA". Retrieved on March 7, 2009 from "Piercing the Corporate Veil: How to Preserve Limited Liability". Retrieved on March 7, 2009 from Read More