Chapter 4 Piercing the Corporate Veil

• 1. Problem generally: One of key attributes is limited liability. In a few very

extreme cases, courts may “pierce the corporate veil,” and hold shareholders personally liable for the corporation’s debts.

• 2. Individual shareholders

• 3. Parent/subsidiary

• 4. Brother/sister

Provisions of Chinese Company Law

• Art. 3 The liability of a shareholder of a limited liability company shall be limited to the amount of its capital contribution.

• Art. 20 Shareholders of a company who abuse the independent legal person status of the company and limited liability of shareholders to evade debts and cause damage to the interests of the creditors of the company shall bear joint liability for the company’s debt.

Factors considered in terms of the Individual shareholders

• The followings are some factors that courts look to in deciding whether to pierce the corporate veil:

• 1. Tort (involuntary) vs. contract (voluntary)

• 2. Fraud or wrongdoing

• 3. Inadequate capitalization• a. Zero capital• b. Siphoning

• 4. Failure of formalities

• In nearly all cases, at least two of the above four factors must be present for the court to pierce the veil. The most common combination is inadequate capitalization plus the last one.

Tort claims vs. contract claims (“voluntary creditor” doctrine)

• Scenario 1: A Sale Delivery Corp.

• mini computer

• On credit balance sheet net worth

• Dennis (Sole shareholder)

• Scenario 2: Peter Delivery Corp.

• hit by the van

• Dennis (Sole shareholder)

• Factors: Can or can not bargain for a personal guarantee?

• Voluntarily or involuntarily to become a creditors?

Fraud of wrongdoing

• Fraud or wrongdoing by the shareholders refers to some means by which controlling shareholders siphoned out its assets or make misrepresentation to shareholders.

• A. Siphons out: Draws a salary that changes from month to month.

• B. Misrepresentation: knowingly and falsely tells creditor that corporation has one million dollars in its bank account.

Inadequate Capital

• Q: whether grossly inadequate initial capitalization, by itself, will suffice to pierce the corporate veil?

• Case: D owns ten corporations, each of which owns two cabs. Each cab is insured for the statutorily-required minimum amount of $10,000. P is severely injured by a cab owned by one of D’s ten corporations, then sues to hold D personally liable, and to hold other nine corporations jointly liable.

Inadequate Capital

• Not usually dispositive:

• 1. Minority view: absolutely affirmative

• 2. Majority view: require either some affirmative fraud or wrongdoing by the shareholder, or a gross failure to follow the formalities of corporate existence.

Inadequate Capital• The situations of inadequate capital• 1. Zero capital: • Case: P Industrial Realty Co.• sub-lease D• Polan Industries

• Other than this lease, Industrial has no assets, no income and no bank account.

• When nothing is invested in the corporation, the corporation provides no protection to its owner; nothing in, nothing out, no protection.

Inadequate Capital

• 2. Siphoning of profits: • Drains out all of the profits and/or capital

whether in the form of salaries, dividends, loans to himself, or whatever.

• Example: A B

• C Controlling Shareholder

• D• E

Inadequate Capital

• 3. Failure to add new capital• The corporation at the time it is set up

has adequate capitalization.

• Due to facts not evident at the time of incorporation, the business’ capital diminishes.

• Q: Should shareholders are required to replenish the capital?

Inadequate Capital

• 4. Business grows

The initial capitalization is adequate, but the business grows to the point where capital that was once adequate is no longer adequate to meet the new likely responsibilities.

Q: Should it be considered “inadequate capitalization” of the sort that should make veil-piercing more likely?

Failure to follow corporate formalities

• A. illustrations: • a. Shares are never formally issued, or

consideration for them is never received by the corporation;

• b. shareholders’ meetings and directors’ meeting are not held;

• c. shareholders do not sharply distinguish between corporate property and personal property.

• d. proper corporate financial records are not maintained.

Failure to follow corporate formalities

• B. Injury to creditor: actual injuries to creditors.

• a. Commingling of legal personalities: taking of cash from the corporation’s bank account to pay personal debts.

• b. Misleading to creditor: putting his personal name on the business door instead of the corporate name, or paying some of its bills with a personal check.

Failure to follow corporate formalities

• C. No injury: In most reported cases where the court pierces the veil, the failure did not injure the creditors.

• a. Possible explanation: shareholder not permitted fist to ignore the rules and then later to claim the advantage to the corporate shield.

• b. Alternative explanation: at least suggest fraudulent transfers may have taken place.

Parent/subsidiary• 1. Greater tendency to pierce

•

• 2. General rule of non-liability: A. Illustration: (1) corporate formalities are observed;

(2)the public is not confused; (3)the subsidiary is operated in a fair manner; and (4)no other manifest unfairness.

• B. Case:

Parent/subsidiary• 3. Factors leading to veil-piercing

• a. Intertwined operations

• b. Unified business and subsidiary undercapitalized:

• c. Misleading to public:

• d. Intermingling of assets

• e. Unfair manner of operation

Brother/sister corporations• Structure: A single corporate parent and multiple

corporate subsidiaries or “children”.

• Case: A1 A2• Parent company A3 A4 A5 Implications: single name advertised in the Yellow

Pages, a single phone number, a single dispatch office, a single repair operation, etc.

Result: be viewed as a single integrated business enterprise.

Distinction between active and passive investors

• Implication: The courts is far more likely to pierce the corporate veil to the detriment of an active investor than to the detriment of a passive one.

• Case: One company consisting of two shareholders, each owning 50% of corporation. Active runs the company from day to day. Passive’s involvement is limited to supplying initial capital. Active commingles his personal funds with those of corporation, fails to see to it that board meetings are held, and misleads creditors into thinking that he is a sole proprietor.

Insider Claims in Bankruptcy

• Generally: Rules would apply when a corporation becomes bankrupt, and shareholders turn out to be creditors.

• Disallowance of claims:• (1) Payment for services: disallow his claim for

the unpaid portion of excessive salary.• (2) Transforming loan into capital: Where the

stated capital is very clearly inadequate for the corporation’s expected business.

Insider Claims in Bankruptcy

• Equitable subordination• 1.Implication: Insiders’ claim be satisfied only after

all other creditors have been fully satisfied.

• 2.Grounds: There is no cut-and-dry test for determining when equitable subordination should be applied. The same rules of piercing the corporate veil apply.

• 3.“Deep Rock” doctrine: named after a subsidiary in a famous case. A parent’s claim against subsidiary is barred.

• 4. Less wrongdoing required:

1.Definition: One single shareholder:natural or judicial?

2. Registered Capital Requirement: stricter or looser?

3. Restrictions on the Establishment of LLC

4. Identification Requirements

5. Special Requirements on Corporate Governance

6. Individual and joint liability

Chapter 4: One-person Limited Liability Companies

Definition

• Article 58

• The term "one-person limited liability

company" as mentioned in this Law refers to a

limited liability company with only one natural

person shareholder or a juridical person

shareholder.

Registered Capital

• Article 59

• The minimum registered capital of one-person limited

liability companies shall be RMB100,000. The

shareholders shall make a one-off capital contribution

in accordance with the provisions of the articles of

association of the company.

Restrictions on the Establishment of LLC

• Article 59 (Section two)

• One natural person is allowed to establish

merely one one-person limited liability

company which shall not set up any further

one-person limited liability company.

Identification Requirements

• Article 60

• A one-person limited liability company shall,

in the company registration, give a clear

indication that it is solely-funded by one

natural person or one juridical person, and

the same shall be specified in the business

license of the company.

Special Requirements on Corporate Governance

• Article 61

• The articles of association of a one-person limited liability company

shall be formulated by the shareholder.

• Article 62

• A one-person limited liability company is not required to establish

the board of directors. When the shareholders make a decision on

any of the matters as listed in Article 38 of this Law, they shall

make it in written form, and preserve it in the company after signed

by the shareholders

Individual and Joint Liabilities

• Article 64

If the shareholder of a one-person limited liability

company is unable to prove that the property of the

one-person limited liability company is independent

from his own property, he shall bear joint liabilities for

the debts of the company.