By: Ryan Pedersen
Abstract
Piercing the corporate veil allows a court to remove the limited liability shareholders in Canada and the US enjoy from their corporations. In both countries, a court will only do so in the interest of justice. However, the Canadian system provides much more clarity into what factual circumstances will lead a court to pierce the veil and the policy rationale behind it. While the Canadian system requires a strict two-part test or a principal-agent relationship to pierce the corporate veil, US jurisdictions take an entirely contextual approach to make these determinations. This paper reviews the history and policy surrounding the doctrine of the corporate veil, its legal frameworks in Canada and the US, and advances the argument that the Canadian system promotes more certainty in the law. Practical recommendations for US appellate courts to adopt aspects from the Canadian system are presented, with counterarguments addressed throughout.
Introduction
Piercing the corporate veil, sometimes also called lifting the corporate veil, is the metaphorical term used to describe when a court finds liability on a corporation’s shareholder for an obligation of the corporation rather than the shareholder. This doctrine effectively allows the court to disregard the corporation’s legal entity and seize assets from a shareholder under circumstances where the shareholder and the corporation are found to be one and the same. One scholar described the doctrine as one “by which courts determine that the corporate form is a sham--that a corporation is being used for some illicit purpose, such as to shield personal assets from personal liability”.1 The doctrine has been adopted in every Canadian and United States (US) jurisdiction. This prompts the research question of this paper: are there differences in the legal frameworks for piercing the corporate veil in Canada and the US that lead one to be better than the other? After reviewing the relevant literature and case law, this paper argues that the US judicial framework surrounding veil-piercing should take a lesson from the Canadian framework in clarifying “when” the veil will be pierced and the policy of “why” it is being pierced.
This paper will begin by exploring the history behind limiting a corporation’s shareholders’ liability. It will then discuss the policy behind adopting such limited liability in the Canadian and US contexts. Then, the policy objectives behind piercing the corporate veil in both contexts will be reviewed and contrasted. Next, this paper will review the Canadian legal framework for advancing veil-piercing claims, followed by a comparative review of the American framework. These reviews will rely on key jurisprudence and scholarly literature to understand the legal frameworks courts in Canada and the US apply to veil-piercing cases. A discussion on the merits of adopting elements from the Canadian framework into the US framework will be presented, highlighting the benefits of doing so. These benefits include increased predictability in the law, maintained flexibility in judicial-decision making, and a more effective oversight mechanism for the activities of international subsidiaries.
History of the Corporate Veil
To understand what might make one veil-piercing framework better than another, it’s important to understand where the rationale behind the corporate veil originates. In Canada and the United States, a corporation and its shareholders are seen as separate legal entities, and the shareholders of a corporation will generally be held immune from legal liability for the corporation’s debts and obligations. This applies whether the shareholders are a natural person or another corporation and is referred to as the doctrine of shareholder immunity or limited liability. The history of limiting the liability of a corporation’s shareholders originated as a privilege for East India companies charted by the English Crown in the early 17th century.2 Since then, scholars have largely attributed the proliferation of shareholder limited liability to firms demanding easier access to capital during the Industrial Revolution.3 However, recent scholarship argues that the proliferation of limited liability stemmed from investors’ demand for safer and diversified portfolios without scrutinizing the other investors involved in their investments.4 When the law permits the shareholders of a company to be absolved from the debts and obligations of the company and its other shareholders, the metaphorical corporate veil is formed, and the only way for these kinds of liability to be imposed on the shareholder is to pierce the veil.
For Canadian federally registered corporations, shareholder immunity is codified in the Canada Business Corporations Act.5 This legislation also applies to companies incorporated in Canada’s northern territories. Provincially incorporated companies also benefit from the shareholder immunity doctrine, codified in all provincial corporate law statutes.6 In the US, shareholder immunity has been a common law principle since the first creditor disputes of the early 1800s.7 Shareholder immunity is codified in the Model Business Corporations Act section 6.22, adopted by thirty-six states.8 For states that have not adopted the Model Business Corporations Act, the doctrine of shareholder immunity is still upheld by statute or common law.9 At common law, the doctrine of shareholder immunity has been defined in the US jurisprudence as “a corporation and its stockholders are presumed separate and distinct, whether the corporation has many stockholders or only one”.10 Now that it has been determined where the corporate veil originates and its legal basis in Canada and the US, this paper will explore some of the policy rationales behind the corporate veil and piercing it in both national contexts.
Policy Behind the Corporate Veil and Piercing It
Policy Behind the Veil
The policy rationale behind the corporate veil is similar in Canada and the US. Limited liability has been described as the “primary benefit of the corporate form”.11 By allowing the shareholders of a corporation to partition their personal assets from that of the corporation (aside from their investments into the corporation’s equity), a balance is struck between the needs of the investor and a corporation’s creditor.12 The carve-out for the investor’s equity stake being seizeable by creditors upon default is the “limited” nature of a shareholder’s limited liability; the corporation’s debts becoming the shareholder’s debts is neither absolute nor non-existent. Under a limited liability system, creditors can be at least partially reimbursed when the corporation falls into default, and shareholders can limit risk to their contribution in the company’s equity.
As well, shareholder limited liability has been argued to encourage business activity.13 The risk-averse investor will give capital to a corporation, thereby increasing its potential value to the economy (in terms of output capabilities), simply because its risk is limited to this capital allocation. Without limited liability, there would be no public capital markets, as investors would not go into business and risk their personal assets becoming seizable for an investment in a company they do not know intimately.14 Without capital markets, all of the benefits of portfolio diversification, wealth distribution, and productivity associated with the markets wouldn’t exist. These economic and risk management considerations are the policy reasons why every jurisdiction in Canada and the US allows the corporate veil of limited liability to partition a corporation’s and its shareholders’ assets.
Policy of Piercing the Veil
Piercing the corporate veil also follows similar policy rationales in the Canadian and US contexts. In Canada, courts pierce the corporate veil when there is justice in removing the shareholder’s immunity for the corporation’s obligations. In this sense, it can be conceptualized as a check and balance against the doctrine of shareholder immunity. Similarly, in the US, the corporate veil will be pierced “when the notion of legal [corporate] entity is used to defeat public convenience, justify wrong, protect fraud, or defend crime”.15 This follows the same basic policy as Canada, where the reasoning behind allowing the veil to be pierced must be in the interest of justice.
In the US context, veil piercing often occurs in cases where creditors, who are in the best position to judge a corporation’s liability risks, have been unable to ascertain the whole truth about the entity to which they have granted some form of credit.16 In tort litigation, plaintiffs seeking to pierce the veil have not necessarily granted financial credit but have been described as “involuntary creditors”.17 In the Canadian context, it has been argued that piercing the veil is more justified in tort rather than contract disputes, as the tort plaintiff never had the opportunity, as mentioned above, to deal with the corporation “with full knowledge of its corporate form and the limited liability associated with it.”18 This sentiment has been echoed south of the border for parent-subsidiary relationships, where tort plaintiffs might be unclear whether they have been harmed by a corporation or one of its many subsidiaries.19 Relatedly, within the literature there has been a call to allow for veil piercing of parent companies or corporate executives to promote oversight of their subsidiaries that operate internationally and hold them responsible for torts committed by an undercapitalized subsidiary.20 These policy considerations allow the veil to be pierced in both Canada and the US in contract and tort claims but with a higher bar for contract cases, again, in the interest of justice.
In both national contexts, the practical reasons a plaintiff would seek to pierce the corporate veil are either to increase the available asset pool and include a shareholder’s assets when the corporation’s are insufficient to satisfy the claim, or as a bargaining chip in settlement negotiations as discovery productions for these kinds of documents are burdensome to produce.21 In the context of a parent-subsidiary relationship, subsidiaries are often given a minimal asset base for their operations, for exactly the reason of limiting liability exposure. Piercing the veil is sometimes the only possible course of action for plaintiffs who have suffered great harm from an undercapitalized subsidiary. It is rare for plaintiffs to pierce the corporate veil in Canada successfully,22 but less rare in the US.23
The Canadian Veil-Piercing Legal Framework
In Canada, a corporation holding a distinct legal personality from its shareholders has been a “bedrock principle of law” since 1897.24 In all civil cases, including claims that the corporate veil should be pierced, the standard of proof is a balance of probabilities.25 Across Canada, the judicial frameworks for veil-piercing are uniform, as evidenced by courts routinely citing non-binding precedence from other jurisdictions in judgements concerning the corporate veil. Three situations allow a veil-piercing claim to be advanced: when a corporation is used by a principal shareholder for improper purposes, when the corporation is a mere agent for the controlling shareholder, or when a failure to pierce the veil would be unfair and lead to a result that is “flagrantly opposed to justice”.26 The first of these theories of case is called domination theory, the second is agency theory, and the third is the flagrant opposition to justice theory.27 Both the domination theory and the agency theory lend themselves to the “alter ego” argument that is common in Canadian and US jurisprudence; that the corporate entity is just the alter ego of its principal shareholder rather than a distinct personality.28 These three situations and the legal discussions surrounding them encompass the Canadian legal framework for veil piercing and will be discussed below, in turn.
Domination Theory
Domination theory is a framework for veil piercing with a two-step judicial test. The test originates from Transamerica Life Insurance Co. of Canada v Canada Life Assurance Co., where the plaintiff must prove first that the corporation was “dominated” by the shareholder in question, and then that the corporation was used to shield conduct akin to fraud.29 This judicial test provides clarity for both parties in a dispute regarding when the veil will be pierced.
The first element of the test requires that the corporation be dominated or controlled so that it “does not function independently” from the shareholder.30 Oftentimes, this kind of claim will be advanced in the parent-subsidiary context.31 As the judicial assumption is that the corporation and its shareholder are separate legal entities, this stage of the test is difficult to overcome.32 This stage of the judicial analysis is highly facts specific and “[t]he decision to pierce the corporate veil will depend on the context”.33 Kosmopoulos v Constitution Insurance Co. of Canada34 is one of Canada’s leading precedents for veil-piercing cases. Heard by the Supreme Court of Canada in 1985, Kosmopoulos concerns an insurance case where the plaintiff obtained property insurance for his store under his name rather than the corporation’s.35 Even though the plaintiff was the corporation’s sole shareholder and controlled all of its affairs, the veil was not pierced, and the corporation and the plaintiff remained distinct legal entities. This is because the plaintiff would have received a benefit if the veil was lifted for him to claim under an insurance policy, and “[h]aving chosen to receive the [limited liability] benefits of incorporation, he should not be allowed to escape its burdens”.36 Kosmopoulos holds that the control element in the test will not be satisfied in cases where piercing the veil would benefit the shareholder. This general rule against using veil piercing to benefit shareholders holds across agency theory and the flagrant opposition to justice theory.
In Fleischer, the control element would have been satisfied at the Ontario Court of Appeal.37 The defendant corporation’s veil was pierced at the trial level to permit personal liability for a judgment against its two principal shareholders. Contextual factors, such as the shareholders each owning 40% of the corporation, personally making misrepresentations on behalf of the corporation and knowing that the corporation was undercapitalized to satisfy these representations, led to veil piercing.38 While the shareholders’ personal assets were not ultimately seized in Fleischer because the damages were considered too remote, the veil would have been pierced if such a finding had been made.39 In Fleischer, the contextual approach to the control element under domination theory is exemplified while also showing that the higher courts have a precedent of deferring to the lower courts on their factual determinations for what constitutes “domination”.
Once control of the corporation has been found, the second stage of the test aims to see if the corporation was incorporated for a fraudulent purpose or was used as a shield for improper activity. An interesting caveat is that this activity does not need to amount to legal fraud, but conduct “akin” to fraud.40 While this seems like it opens the door to courts finding personal liability on shareholders in an unprincipled fashion, Canadian courts exhibit great restraint in practice. This element of the test can be satisfied when “those in control expressly direct a wrongful thing to done”.41 In Fleischer, this element was satisfied by the principal shareholders of a corporation who undertook to the court to purchase assets. However, they broke their undertaking to do so when market factors made those assets less desirable. The breaking of the undertaking was considered a wrongful act, and piercing the corporate veil in this instance would have furthered the policy of preserving the importance of sworn undertakings in the interest of justice.42
Cases of actual fraud will satisfy this element as well. In Shoppers Drug Mart Inc. v 6470360 Canada Inc.,43 the defendant corporation was owned by a sole shareholder (who was also the company’s sole director and officer).44 The corporation misappropriated the plaintiff’s funds based on the sole shareholder’s direction, leading to the unjust enrichment of the sole shareholder and the veil being pierced to recover the money.45 Canada (Attorney General) v Transcona Country Club Ltd. provides precedent on the proposition that incorporating a company for fraudulent purposes will lead the veil to be pierced.46 Transcona holds that in insolvency proceedings, a company may not sell its assets to another version of the same company. Doing so will satisfy both elements of the domination theory test and lead the corporate veil to be pierced so creditors may recoup these assets.47
While the above cases highlight examples of the impropriety element, the contextual nature of the domination theory analysis provides judicial discretion to exercise piercing the corporate veil when necessary. It seems this is only done in practice across Canada when a corporation’s assets cannot satisfy the harm created by their conduct akin to fraud, and the shareholder had specific knowledge of dishonesty. This framework provides both creditors and shareholders with certainty that the corporate veil will only be pierced when the shareholder dominates the corporation’s activities and that the shareholder did so with some personal dishonesty that led another party to be harmed.
Agency Theory
A principal-agent relationship is established when a principal party gives authority to another party (the agent) to act on their behalf in such a way that can affect the first party’s legal position in contracts or the disposition of property.48 The principal will be bound by the acts of the agent when the agent is acting within the scope of their given authority or their “apparent” authority (in the eyes of a reasonable third party).49 In formally established agency relationships, a corporation acting as an agent for its controlling shareholder will be sufficient to establish the corporation as merely the shareholder’s alter ego and remove shareholder immunity.50 When determining whether an “apparent” agency relationship exists between the corporation and its principal shareholder, the courts have looked to see whether the shareholder has an “intimate and immediate domination” of the corporation so that it has “in the true sense of the expression, no independent functioning of its own”.51 In White v E.B.F. Manufacturing, a principal-agent relationship was found to overcome the shareholder immunity rule and pierce the corporate veil in a parent-subsidiary context. In this case, it was not an express agency relationship, but the courts found an apparent agency.52 Factors that led to this determination include the subsidiary company being controlled by the same sole shareholder as the parent, being used just as a “mere sales station” for the parent company, and the subsidiary being the parent’s only customer.53 These elements amounted to the inference that the subsidiary was always acting on behalf of the parent to the same degree an agent would. While no element was akin to fraud in White, a judgment against an undercapitalized agent can prompt a veil-piercing review. It would also appear from White that mere ownership of shares and common management of both parties does not constitute the principal-agent relationship.
The agency theory seems, at first instance, less robust in providing certainty about when and why the veil will be pierced than the domination theory, as it functionally removes the impropriety element needed in the domination theory test. However, in a principal-agent relationship, removing the element of impropriety makes sense because the veil will only be pierced when an obligation has been entered into on behalf of the principal. As veil-piercing is only pursued at the trial stage by plaintiffs in cases where the corporation is undercapitalized to settle its obligations, it is logical to skip the impropriety element in a scenario where the corporation is being used to facilitate a deal between the injured party and the corporation’s principal shareholder. With the high bar created in White’s wording, such an agency relationship will not and has not been easily found by Canadian courts.
Flagrant Opposition to Justice Theory
Created in the obiter of Kosmopoulos, the flagrant opposition to justice theory is somewhat of a catch-all to be argued in cases that fit outside of the scenarios mentioned above. It states that a court may pierce the veil where declining to do so “would yield a result “too flagrantly opposed to justice, [or] convenience[…]””.54 This seems to create a broad judicial power to pierce the corporate veil without any sort of judicial test that defines when or why the veil will be pierced.
However, the wording in Kosmopoulos (and the subsequent decline to pierce the corporate veil in that case) set a precedent for judicial restraint, which Canadian courts have followed. In practice, courts revert to the elements of domination theory. In Gregorio v Intrans-Corp., liability was imposed on a parent company for negligence by a wholly owned subsidiary.55 It appears that the flagrant opposition to justice theory was used to support this decision at the trial level, as the steps in the domination theory were not followed, and an agency relationship was not argued. However, this finding was overturned by the Ontario Court of Appeal, commenting that owning one hundred percent of a company’s shares will not be enough to find complete control and reinforcing that piercing the veil should be applied only to prevent conduct akin to fraud.56 Similarly, in Haskett v Trans Union of Canada Inc.,57 the domination theory elements were cited as a reason not to pierce the corporate veil in the context of a US company with tortious subsidiary conduct in Canada.58 Although the claim was that the parent company’s directives created the negligent conduct in Trans Union, since the corporate form wasn’t being used as a shield for misconduct, the veil-piercing claim failed on appeal.59 Yaiguaje v Chevron Corporation offers the latest attempt to pierce the veil under the flagrant opposition to justice theory.60 In Chevron, the Ontario Court of Appeal denied the proposition that Kosmopoulos permits the flagrant opposition to justice theory and references that domination and agency theory are the only acceptable ways to pursue a veil-piercing claim.61
It does not appear that the flagrant opposition to justice theory has ever survived appeal and become a binding precedent.62 This bolsters the credibility of the Canadian veil-piercing framework, where corporations and their shareholders can reasonably expect to rely on the doctrine of shareholder immunity to preserve a shareholder’s limited liability status except in the defined scenarios of the domination and agency theories. While the question of when the veil will be pierced remains somewhat questionable with the catch-all argument of the flagrant opposition to justice theory, there is no problem with unexpected veil piercing in reality. The flagrant opposition to justice theory remains useful as a judicial mechanism for rectifying extenuating circumstances that the law has not contemplated. Having judicial discretion in a veil-piercing framework is amicable in a jurisdiction like Canada, where the policy rationale behind why the veil will be pierced is very clearly articulated as being centred around facilitating justice. While justice is a subjective construct, only using veil-piercing to benefit those harmed by shareholders abusing the corporate form to shield their willful misconduct from liability appears to fall within the Canadian court’s view of justice. Canadian courts may one day accept the flagrant opposition to justice arguments in distinguishable circumstances from the precedent cases. Next, this paper will turn to the US framework for veil-piercing and examine the factors that explain when and why a court will pierce the veil.
The US Veil-Piercing Legal Framework
Unlike the Canadian legal framework, there is no true uniformity in judicial decision-making across the US. However, there are common themes for why the veil will be pierced in the US, which will be discussed below. As there is uncertainty about when the veil will be pierced within the US framework, creditors are always incentivized to commence litigation, and defendants have little incentive to settle. This is why piercing the corporate veil has been described as one of the most litigated issues in US corporate law.63 Most states leave questions about when and why the veil will be pierced to their court systems, not including the answers to these questions in their corporate statutes.64 This creates veil-piercing precedent systems within the 50 state-level jurisdictions in the US, often with overlapping themes in cases where the veil is pierced.
The Overarching System
If corporations successfully argue the internal affairs doctrine, they will be held to the state law in which they are incorporated.65 This common-law rule states that corporate governance issues are to be adjudicated under the law of the state where the corporation was formed,66 but are not always successfully pled (especially in tort cases).67 Veil piercing has relatively high success rates in the US; these claims seem to have the same success rate at the federal or state level courts.68 It has also been stated that the veil of a public company has never been pierced in the US, with successful veil-piercing jurisprudence coming only from closely held corporations.69 Like Canada, US courts often cite precedence from other jurisdictions when deciding on a veil-piercing case.
One explanation for the lack of uniformity across the US for veil-piercing is that if a court implements a multi-factor test, it will always do so with a high level of judicial discretion built into it.70 This judicial discretion is often exercised because a “guiding concept behind... veil-piercing cases is the need for the court to 'avoid an over-rigid preoccupation with questions of structure... and apply the preexisting and overarching principle that liability is imposed to reach an equitable result”.71 Judicial decision-making for veil piercing in the US has been described as being decided “by characterization, epithet, and metaphor […] rather than on carefully articulated reasons” more than any other area of law.72 There have been calls in the literature to abolish veil piercing in the US altogether due to the unpredictability of personal liability that the doctrine imposes on shareholders.73 There have also been calls for different frameworks for piercing the veil of a closely held corporation to seize the assets of a natural person and that of a parent-subsidiary corporate relationship.74 The US framework is similar to the Canadian one in that it has equitable policy foundations,75 and remains highly contextual.76 Next, this paper will explore some of the most common factors that US courts examine when weighing whether to pierce the corporate veil.
Factors for Veil Piercing
Common elements have emerged in the few empirical reviews of veil-piercing cases in the US.77 The following discussion will be limited to these most common elements. However, “the list of justifications for piercing the corporate veil is long, [and] imprecise to the point of vagueness.”78 In each jurisdiction, a court decides whether to pierce the veil by combining these factors within the overall context of the dispute. After discussing the individual factors, some of these different frameworks will be discussed.
Alter ego. Like the Canadian domination and agency theories, US courts will often look to see if the corporation is just the “alter ego” of the shareholder. Unpacking this metaphor reveals that courts look for whether the corporate form is being used solely for the business activities of the principal shareholder.79 Terms like alias, stooge, instrument, and dummy are used interchangeably with alter ego, among other colourful metaphors.80 This analysis of the corporate form will be highly context-specific. Since the corporate form at its root is used to carry on the business activity of natural persons, this analysis will almost certainly include an element of impropriety or fraud in business dealings, although this element is not required in every jurisdiction.81 The alter ego analysis often relies on the other factors below, or sometimes the other factors combined will add up to an alter ego finding. Any one factor alone will not be enough to warrant overcoming the statutory rule of shareholder immunity.82
Undercapitalization. Undercapitalization is a frequently cited factor US courts use when deciding to pierce the veil. Analyzing capital requirements for any corporation is context-specific to the industry and region.83 Some jurisdictions require the undercapitalization to be “gross” to attract veil-piercing liability.84 While previously cited as the most reliable factor that will lead to veil piercing, more recent scholarship has refuted this.85 The premise behind reviewing undercapitalization is an inference that a corporation holding less capital than it should is evidence that the corporate form is only used to shield liability for its shareholder’s wrongdoings. In DeWitt Truck Brokers v W. Ray Flemming Fruit Co., a business holding only $3,000 in cash funds despite needing much more to operate led to the adduction (among other factors) that the business must have been financed by the principal shareholder, warranting personal liability on this shareholder for the corporation’s debt.86 In contrast, in Trustees, Nat. Elevator Industry Pension v Lutyk,87 the trial-level finding of undercapitalization using the corporation’s debt-to-equity ratio was overturned because it failed to consider greater economic and business-specific factors affecting that ratio.88 DeWitt and Lutyk highlight this factor’s contextual yet somewhat contradictory nature across different contexts.
Nonpayment of dividends. The nonpayment of dividends to shareholders is included in some jurisdictions’ list of factors as a reason to pierce the corporate veil.89 The rationale is that normal corporate activity for a profitable entity will involve paying dividends to shareholders, and the nonpayment of dividends may indicate that the corporation is being used for another purpose by the principal shareholder. However, the jurisprudence in the US is contradictory, as sometimes a corporation’s payment of dividends has been used as a factor to pierce the veil as well.90 The payment of dividends has attracted veil piercing in the US when they are used to siphon funds to the principal shareholder.91 Like undercapitalization, the payment or nonpayment of dividends provides little certainty for shareholders looking to order their affairs to avoid personal liability.
Failure to observe corporate formalities. Similar to the nonpayment of dividends, a failure to observe the formalities typical of a legitimate corporation has been factored to pierce the veil. Such formalities include holding shareholder meetings, recording the minutes of these meetings, preparing annual documents for shareholders, holding bank accounts in the corporate name, and more context-specific factors that might lead a court to believe that the corporation is being used for a shareholder’s personal dealings. In Riggins v Dixie Co., Inc., it was discussed that a departure from corporate formalities must be “substantial” to remove shareholder immunity.92 In Riggins, factors such as the corporation’s failure to keep records of employee payments, the property of the shareholder being used without remuneration, and a lack of shareholder’s meeting minutes were weighed in favour of piercing the corporate veil.93 In contrast, factors such as the maintenance of corporate bank accounts and proper corporate tax filings were weighed against piercing the corporate veil.94 Riggins provides an example of what the courts look for in this factor: evidence that the corporation is indeed a “real” corporation rather than merely the shareholder using a corporate name.
Intermingling of activities and assets. Another factor courts have routinely looked for as evidence that the corporate form is being used as a shield for impropriety is when the division is unclear between the principal shareholder’s assets and the corporation’s. This has been referred to in the jurisprudence as an “intermingling” or “commingling”. In Cancun Adventure Tours v Underwater Designer Co.,95 the corporate veil was pierced. There, the shareholder owned a physical office, but corporate funds were used to pay the mortgage and rent to the shareholder, as well as improper personal expenses such as dry cleaning and massages.96 Similarly, corporate funds used by the corporation in a manner that only the shareholder would use them has been seen as an intermingling of activities.97 Common control between one corporation and another will not alone suffice as an intermingling of business activity.98 In the context of grouped companies, such as a parent-subsidiary relationship, if there is reasonable confusion as to who a plaintiff was dealing with, then this may suffice as an intermingling of activities to warrant piercing the veil.99
These non-exhaustive factors encapsulate the most common considerations when deciding to pierce the corporate veil. Next, a brief note on several judicial tests for piercing the veil in different US jurisdictions will be reviewed.
Judicial Tests
Courts will sometimes use the above factors, among others, to determine whether the shareholder is abusing the corporate form to warrant personal liability. The Third Circuit Court of Appeals has stated the following factors as the ones it will consider:
“gross undercapitalization, failure to observe corporate formalities, nonpaymement of dividends, insolvency of debtor corporation, siphoning of funds from the debtor corporation by the dominant stockholder, nonfunctioning of officers and directors, absence of corporate records, and whether the corporation is merely a facade for the operations of the dominant stockholder”.100
Similarly, the First Circuit requires the following twelve factors to be examined:
“(1) common ownership; (2) pervasive control; (3) confused intermingling of business activity assets, or management; (4) thin capitalization; (5) nonobservance of corporate formalities; (6) absence of corporate records; (7) no payment of dividends; (8) insolvency at the time of the litigated transaction; (9) siphoning away of corporate assets by the dominant shareholders; (10) nonfunctioning of officers and directors; (11) use of the corporation for transactions of the dominant shareholders; (12) use of the corporation in promoting fraud”.101
As well, the Seventh Circuit requires only the following four factors to be examined: “(1) the failure to maintain adequate corporate records or to comply with corporate formalities, (2) the commingling of funds or assets, (3) undercapitalization, and (4) one corporation treating the assets of another corporation as its own”.102
Comparing these three appellate courts in the US reveals the inconsistency among judicial approaches toward piercing the corporate veil. Moving to the state-level courts, this inconsistency becomes even more noticeable, with fifty different sets of overlapping criteria. While all jurisdictions seem to fundamentally hold that the reason why the veil should be pierced is limited to an equitable remedy, the trial and appellate-level judgements do not explicitly say so. The question of when the corporate veil will be pierced is unclear and varies significantly by jurisdiction and contextual factors. Next, this paper will present its principal arguments about elements the US veil-piercing framework can adopt from the Canadian version to improve its shortcomings.
What the US Can Learn from Canada
The above examination of the Canadian and US frameworks reveals similarities and shortcomings in the two judicial decision-making schemes. In both countries, it becomes evident that piercing the veil serves the same equitable purpose of making whole a plaintiff injured by a shareholder seeking to abuse the corporate privilege of limited liability. In Canada, this policy rationale is forwarded clearly through the legal framework, while in the US, it is not as clear.
What might be an optimal veil-piercing framework, considering the policy rationales and history behind the corporate veil and piercing it? First, this paper argues that shareholders should have a framework that clarifies when and why the veil will be pierced. As limited liability is the primary benefit of incorporating, a reliable veil-piercing framework will allow shareholders to order their affairs and activities with less risk, promoting economic activity while also having a mechanism to punish shareholders who abuse the corporate form. Certainty in business law is always preferable to variability.
Secondly, the framework should provide as much uniformity across jurisdictions as possible. The reasoning behind this is the same as the reasoning for clarity, as businesses will be promoted to expand their business affairs across a nation without needing to re-order their affairs per state. Business activity is hampered when activity in one jurisdiction is acceptable for a shareholder to remain immune from corporate obligations but not in a neighbouring jurisdiction.
Thirdly, an optimal veil-piercing framework will have a mechanism of judicial discretion built into it as a failsafe, only to be used in extenuating circumstances. Like many areas of the law, creating an opening for the law to develop and accommodate for unforeseen future challenges is necessary to prevent over-rigidity and injustice.
Lastly, an optimal veil-piercing framework will be able to deal with the oversight of foreign subsidiaries appropriately. While the first three criteria deal with the protection of the shareholder, this criterion attempts to address a recurring issue faced by plaintiffs in veil-piercing cases. The US framework can use the Canadian framework as an example for the first of the three criteria. The fourth is a criterion that no one has quite perfected yet. While the Canadian veil-piercing framework and jurisprudence are less developed than in the US, it remains more articulate, predictable, and has a much higher rate of leaving shareholder immunity intact.
Improving When and Why the Veil Will Be Pierced in the US
The discussion above shows that the US framework lacks clarity regarding when and why the veil will be pierced. The current judicial decision-making mechanism in the US leaves courts with full subjectivity in deciding whether the corporate form is being misused. While there are factors courts are supposed to review, the relative weight of each factor has no precedent, and this opens the door to injustice for shareholders or harmed plaintiffs.
In contrast, the Canadian framework is clear and all-encompassing. Unless the carefully articulated control and impropriety elements are met or a principal-agent relationship is evident, the veil has not been pierced. This high bar promotes certainty for plaintiffs and corporate defendants regarding how to order their affairs and when to fight or settle in the context of a dispute. The US framework should adopt the Canadian two-part test while implementing factors such as undercapitalization, nonpayment of dividends, failure to observe corporate formalities, and the intermingling of assets into the control element of the test. This would allow the US law to incorporate its precedent while closing the holes in the framework that leads to so much uncertainty.
Regarding the impropriety element, the US judgements have insufficiently articulated the policy reasons why the veil is being pierced. Yale and Columbia Law School Professors Jonothan Macey and Joshua Mitts have argued that while not articulated, every case where the veil was pierced in the US can be taxonomized as furthering one or more of the following three policy objectives: piercing the veil will align a corporations behaviour with a statutory scheme, there is conduct akin to fraud without the common law elements of fraud being satisfied, or the bankruptcy values of avoiding fraudulent conveniences and preferential transfers have been frustrated.103 Using these three policy objectives as the basis for the impropriety element in the two-part test is empirically supported as following the US precedents while carefully articulating when and why the veil will be pierced, solving the US system’s shortcomings in these domains.104 While it can be countered that judges will still be left with subjectivity when deciding if the facts of a case justify piercing the veil for one of the three policy reasons, therefore leaving uncertainty in the system, some level of uncertainty is inherent in any litigation. Carefully articulating the reasons for the policy that will cause the veil to be pierced significantly reduces the uncertainty in the current US framework.
Adopting such a two-part test across the US would be optimal for the benefits of uniformity described above. While this might be difficult to implement because corporate law is a state-level issue, as appellate-level courts serve multiple states, adopting the two-part test at the appellate level would bind lower courts in multiple jurisdictions simultaneously. As the two-part test is just a re-articulation of the current precedent, appellate courts can adopt it without changing the substantive law. While some may argue that uniformity in US corporate laws will hurt the competitive economic advantage that some jurisdictions like Delaware enjoy, these jurisdictions have been described as enjoying this advantage due to their certainty in corporate laws.105 Increasing certainty in corporate law through uniformity of “the primary benefit of the corporate form”106 can only be argued to be good for the US legal landscape.
The Optimal Level of Judicial Discretion
The US framework should adopt the Canadian level of judicial discretion. Judicial discretion is important to ensure fairness and account for the uncertainties of the future. However, the current US framework relies too much on judicial discretion when weighing whether to pierce the veil. Besides the regular discretion accompanying the standard of review in civil matters, the Canadian system’s supposed “safety valve” of the flagrant opposition to justice theory offers the optimal amount of judicial discretion. This is because courts have created an extremely high bar to use it. Such safety valves exist in other areas of Canadian law, such as the GAAR in tax law. Creating a carveout that allows for judicial discretion in the US system will ensure that the corporate veil can be pierced in extremely rare circumstances where the test fails to ensure justice.
The oversight of foreign subsidiaries could be an example of warranting the safety-vale mechanism of judicial discretion. As argued to be the case in Chevron, sometimes a large multinational corporation will abuse a developing nation’s weak legal system and use its subsidiaries to commit illegal acts abroad. In other jurisdictions, such as Germany, parent companies will be liable to absorb the losses of their subsidiaries, creating different kinds of limited liability for natural persons and corporations.107 While Canadian courts have rejected this form of liability for parent corporations, known as group enterprise theory of liability,108 current veil-piercing frameworks do little to punish parent corporations who derive profit from wrongdoing subsidiaries that they create. Sophisticated multi-national corporations, such as Chevron, will order their affairs through so many layers of corporate holding companies that the parent company will likely never be found liable, no matter what actual involvement the parent company had.109
Chevron did not provide the right opportunity to enforce liability on the parent company for a judgment against its subsidiary because of the allegations of fraud surrounding the judgment against the subsidiary.110 However, if similar facts were to arise where a corporation derives profit from the actions of a subsidiary, a lawful judgment is obtained against the subsidiary, and the subsidiary refuses to pay, plaintiffs should have some form of recourse against the parent company that profits from their harm. This recourse can be piercing the corporate veil when refusing to do so would be flagrantly in opposition to justice. However, this can be criticized as opening a dangerous precedent that undermines the benefits of certainty and could theoretically dissuade large corporations from doing business in the US. Using the safety-valve mechanism relies on the subjective importance of holding a global perspective in corporate law that balances the want for profit and rectifying the harm that this profit can cause.
Conclusion
In conclusion, the US judicial framework surrounding veil-piercing should take a lesson from the Canadian framework in clarifying “when” the veil will be pierced and the policy of “why” it is being pierced. This will lead to benefits such as decreased litigation through an increase in reliability in corporate law. Both the US and Canadian veil-piercing legal frameworks come from the same policy perspective that limiting the liability of shareholders has economic benefits but should never be absolute. Adopting the Canadian two-part test into the US legal framework can help improve predictability and uniformity in the otherwise irreconcilable mass of US precedents. By localizing the test to include the factors US courts frequently examine into the control element and basing the impropriety element on US policy, the Canadian approach can be adopted without violating stare decisis. Including a reserved amount of judicial discretion for when the veil should be pierced can create a system that is equipped for the unknown challenges of the future, and prevent gross injustice in the most extreme cases that currently have no recourse. While such a radical shift in the US veil-shifting framework is unlikely to become a reality, radical thinking is required to initiate any kind of change. A continued line of scholarly and judicial critiques of veil-piercings shortcomings in the US for both shareholders and injured plaintiffs may slowly change the system to one that is more certain.
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