Business Lawyer Advises: Piercing Through the Corporate Veil
Piercing Through the Corporate Veil
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The Corporate Veil | Businesses often choose to incorporate because corporations operate as separate legal entities, shielding the personal assets of shareholders from creditors. Many people think that they can hide behind corporations. While the corporate veil will often protect shareholders, directors and officers from personal liability, there are some situations where the court will pierce through the corporate veil, holding them personally responsible.
It is important for creditors to understand when the veil can be pierced because a court judgement against a corporation can be challenging to enforce. Many numbered companies have no assets to enforce judgments against, leaving the creditor without a means of collecting the money owed to them and effectively rendering the court judgement useless.
Similarly, it is important for corporate shareholders to understand when they may be found personally liable for corporate debts, and other liabilities, and what steps they can take to protect themselves. Directors and officers, for example, should consider purchasing directors and officers’ liability insurance.
While historically the courts have been reluctant to pierce through the veil, there are a few exceptions where they will. For example, the veil has been pierced in cases involving fraud, misappropriation of funds, serious tortious conduct and where personal guarantees or promises are provided to secure corporate obligations.
Here are some key cases that clarify when the court can pierce the corporate veil:
642947 Ontario Ltd. v Fleischer
In Fleischer, the court defines two situations where the corporate veil can be pierced:
- The veil can be pierced when the company is incorporated for an illegal, fraudulent or improper purpose, or
- Where those in control expressly direct a wrongful thing to be done.
This prevents people from being able to hide behind a corporation where they have committed wrongful or illegal acts.
Shoppers Drug Mart v 6470360 Canada Inc.
In Shoppers Drug Mart, the Court of Appeal applies the test from Fleischer and clarifies that the veil can be pierced where the corporation has only one officer, director and shareholder. In situations where there is only one, or a small number, of shareholders, directors and officers, it is easier to see who directed the wrongful act to be done. This is why it is more common for the court to pierce the veil where corporations are held more closely instead of a private company with 100 shareholders, for example.
Lynch v Segal
In Lynch v Segal, the court states that the veil can be pierced in situations where not piercing the veil would create an unjust result in the realm of family law. The court pierces the veil in a separation proceeding where almost all of Segal’s assets were shielded inside corporations. If the court had not pierced the veil in this case, Lynch would have been denied assets of the marriage that she is rightfully entitled to, creating an unjust result.
Sunview Doors Limited v. Pappas
The court will often pierce the veil in construction cases where there has been a breach of trust. A breach of trust occurs when any person from a corporation receives money for a construction project and subsequently fails to use that money to pay for services and materials supplied to that project. Section 13 of the Construction Lien Act allows the court to make any person who has effective control over a corporation or its activities personally liable for a breach of trust. This allows trades and suppliers to secure payment through personal liability against a contractor, subcontractor or owner who breaches trust.
In Sunview Doors, the court determined that one of the shareholders from the corporation was personally liable for the breach of trust that occurred when funds that were paid to the corporation for a project were disbursed to the shareholder’s personal account instead of being paid to Sunview Doors for materials supplied to the project. This offers protection to trades and suppliers at the bottom of the construction pyramid who are too often left unpaid on construction projects.
Developments in case law have made it increasingly harder for people to hide behind a corporation in situations where there has been wrongful conduct. While the courts are still reluctant to pierce the veil, it has been done in numerous cases. The courts have made it clear that the corporate veil can be pierced where the company is incorporated for an illegal, fraudulent or improper purpose, where those in control of the corporation expressly direct a wrongful thing to be done, where not piercing the veil would lead to an unjust result and where there has been a breach of trust under the Construction Lien Act.
Corporations should take steps to protect shareholders from liability. Corporations can increase distance between shareholder and corporate assets through separate bank accounts and contracts, making it more challenging to pierce the veil. The incorporation and organization of a more complex web of corporations may also assist.
Please contact Michael Paiva for more information about piercing the corporate veil, or if you require assistance with a potential corporate law litigation matter. Michael was recently successful at trial in defence of a shareholder, officer and director in the Plaintiff’s attempt to hold his client personally liable for a corporate debt.