Business Law and Business Litigation: Statistics Show Why Courts Pierce the Corporate Veil
By: Gerald Peake
What are the benefits of forming a business entity? The answer to this question almost invariably includes the ability to limit the liability of a business owner to the extent of the owner’s investment. This critical benefit, however, is not absolute, and may be overcome by the one of the law’s most colorfully named and seemingly familiar doctrines: piercing the corporate veil. With piercing, the corporate alter ego is disregarded in order to hold the corporate owners liable.
Depending on your practice areas, the piercing doctrine may be a useful tool or another risk to be managed, but it is critical to have an understanding of how the doctrine applies in practice. Fortunately, the nuances of how courts pierce have been illuminated in a fascinating study by John H. Matheson, “Why Courts Pierce: An Empirical Study of Piercing the Corporate Veil,” published by the Berkeley Business Law Journal in 2010.
This research provides a statistical analysis of 929 piercing cases and reveals a number of interesting facts, including the following:
Courts pierce to hold individuals liable at roughly twice the rate of piercing in the parent-subsidiary context.
Entity plaintiffs successfully pierce at roughly twice the rate of individual plaintiffs.
Piercing is more likely in a contract claim than in a tort claim.
Factors such as fraud, owner dominance, commingling, and fairness have a statistically significant impact on the likelihood of piercing. All other factors generally do not have a significant impact on piercing.
It is important to keep in mind that the study’s descriptive data does not necessarily reveal a causal relationship and that many variables may influence the outcome of a matter. This is the case for the type of claim brought; the descriptive statistics show that piercing is more likely on a contract action, but the study’s regression analysis (a statistical process) does not indicate that this correlation is causal.
Additionally, the study suggests that the difference in piercing rates by plaintiff type may be the result of individual owners simply being less diligent than corporate owners. Even these descriptive statistics are valuable in assessing risk and coloring litigation strategy. The statistically significant impact of fraud, owner dominance, commingling, and fairness however provide a strong signal as to which factors best explain how piercing occurs.
Given the framework provided by this empirical research it is clear that not all factors are equally important, and some factors are likely to be unimportant. This is helpful guidance in the context of New Hampshire case law, because the New Hampshire Superior Court in PlasTech Machining & Fabrication, Inc. v. StemTech, Ltd. (NH Super., 2014) and Greg Gendron Assocs., LLC v. Nashua Circuits, Inc. (NH Super., 2014) used a 12-factor test for piercing.
In those cases, the Superior Court aptly observed that New Hampshire piercing cases “are grounded in their specific facts, and do not set forth a broad framework for analysis.” That said, while the factors test provides helpful guidance in the difficult question of what is equitable and fair, we may also use the empirical research to partly fill the analytical gap.
The empirical research is further supported by case law from the New Hampshire Supreme Court, which has “held that a court may pierce the corporate veil if a shareholder suppresses the fact of incorporation, misleads his creditors as to the corporate assets, or otherwise uses the corporate entity to promote injustice or fraud.” Druding v. Allen (NH, 1982). It is arguable then that the question of fraud, particularly in New Hampshire, is a critical linchpin of the piercing analysis, rather than merely one factor out of many.
This conclusion is intuitive because the New Hampshire Supreme Court cases have described the piercing doctrine as an equitable remedy. See generally Holloway Auto. Grp. v. Lucic (NH, 2011). While there is no case law explicitly holding that corporate formalities are not equitable factors, each of the elements highlighted by the Druding court relate to the question of equity, rather than whether a defendant was following corporate formalities. Equity, after all, is a question of fairness rather than one of mechanical formalism. As such, fraud is a vastly more important factor than factors like the absence of corporate records or the nonfunctioning of officers and directors.
While this framework is helpful, it is important to bear in mind that in some instances the line between fraud and corporate formalities may be blurred. An example of this can be seen in the Border Brook Terrace Condominium Ass’n v. Gladstone (NH, 1993) case where the underlying jury instruction on piercing read, “[w]hether the trust or corporation was established or carried on without [sufficient] assets to meet its anticipated debts and obligations.” In this language, the undercapitalization factor is presented as a question of fairness. A clever advocate with the appropriate factual backing has the opportunity to reframe issues to emphasize or deemphasize their importance.
Overall, this research provides a lucid example of how legal practice may benefit from data-driven studies. I urge any practitioner engaged in piercing litigation or advising a client on risks of piercing to read the study in full, which is available online for free. The research is presented in such a way that even attorneys who are unfamiliar with statistics will be able to understand some of the material. Empirical research is a critical tool in understanding how what courts do may diverge from how legal tests are articulated. In the case of piercing, it helps demystify the diaphanous veil into something a bit more concrete.
Gerald Peake is a consulting attorney and the principal of the Law Office of Gerald D. Peake, where he assists clients with business entity formations, civil litigation, intellectual property, and family law matters.