1. Piercing the Corporate Veil
Boris J. Steffen, CPA, ASA, ABV, CDBV
Principal & Director
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2. Overview
» Parameters of the corporate veil
» Theories used by courts to pierce the corporate veil
» Indicia of alter ego and instrumentality
» Relationship between alter ego, fraudulent and preferential transfers
» Summary
» Expert profile
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4. By law a corporation is a legal entity separate and distinct from its
shareholders
» The legal distinction between a corporation and its shareholders acts as a
“veil” to limit the liability of shareholders to the value of their investment
» Notwithstanding, however, courts will pierce the corporate veil to
› prevent fraud
› achieve equity
› or prevent the violation of a statute or public policy
» Generally, there are two conditions common to the courts’ piercing of the
corporate veil
› The existence of a unity of interest and ownership such that the separate identities of
the corporation and its owners no longer exist
› Recognition of the corporation as a legally separate entity will lead to an unfair result
» Certain cases also require proof of fraud, demonstrated by
› intent,
› bad faith
› or injustice
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6. The principal theories relied on by courts to pierce the corporate veil are
alter ego and instrumentality
The theory for Instrumentality is
The theory of Alter Ego rests on a that a dominant entity should be
belief that if a corporation’s owners held accountable for using a
disregard its separateness, its subservient entity as a fiction for its
separateness should also be own purposes. Accordingly, the
disregarded to protect creditors. corporate veil will be pierced if the
Tests under Alter Ego focus on the following occur:
occurrence of two outcomes: •Domination of the disputed
•The corporation was so influenced transaction occurred such that the
as to create a unity of ownership corporation had no separate mind,
and interest such that it ceased to will or existence of its own;
exist separately •Defendant used such domination
•Recognition of a separate to perpetrate a fraud or wrong;
corporate existence would •And such domination was the
perpetuate a fraud or injustice proximate cause of a loss or unjust
injury
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7. Courts dissatisfied with alter ego and instrumentality theories have
developed tests under theories of equity
» Tests developed by the courts under theories of equity focus on specific
case factors including
› Undercapitalization
› Failure to observe corporate formalities
› Nonpayment or overpayment of dividends
› Siphoning of funds or guarantee of liabilities by dominant shareholders
» Courts may also pierce if a corporation has relied on its form to violate a
public policy, statute, or commit fraud:
› A corporation creates a new entity controlled by the same persons to
discharge unwanted debts while undermining the ability of the previous
corporation to pay the debt
› A corporation liquidates in order to avoid liability for violation of an
antitrust, environmental, employment, or other regulatory statute
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9. Indicia of alter ego
Domination Financial
and control dependence
Relevant
Alter Ego
Market
Confusion of
Lack of
corporate
separateness
identity
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10. Factors indicative of alter ego
Financial Identity Lack of Control and
dependence confusion separateness domination
Undercapitalization X X X
Unable to operate as X X X
standalone
Related party transactions X X X
to benefit owners and
subsidiary
Insolvency X X
Common management, X X
business activity
Lack of corporate X
formalities
Preference of creditors X X
De Facto Merger X X
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11. Indicia of instrumentality
» Majority ownership of subsidiary capital stock by the parent corporation
» Common directors and officers within the parent and subsidiary
» Subsidiary financing by parent
» Parent subscribes to all subsidiary capital stock or causes its incorporation
» Inadequacy of subsidiary capital
» Parent payment of subsidiary salaries, expenses, and losses
» Subsidiary has no business or assets except those given by parent
» Corporate documents and officers describe the entity as a department or
division of the parent, and identify its businesses and financial obligations as
the parent’s
» Parent use of subsidiary property as its own
» Subsidiary executives act on the order, and in the interest, of the parent
» Failure of the subsidiary to follow its own legal requirements
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12. Factors indicative of instrumentality
Financial Identity Lack of Control and
dependence confusion separateness domination
Parent corporation X X
ownership of majority of
subsidiary capital stock
Common parent and X X
subsidiary directors and
officers
Financing of subsidiary X X
by parent
Inadequacy of subsidiary X X
capital
Parent payment of
subsidiary salaries,
X X
expenses, and losses
Subsidiary executives act
on the order, and in the
X X
interest, of the parent
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14. While equity courts do not follow bankruptcy rules, the indicia of alter
ego are characteristic of preference and fraudulent transfer claims
Under Section 547 of the Code, a transfer Under Section 548 of the Code, a transfer
is preferential and avoidable if it: may be avoided as fraudulent if
» benefited a creditor » made with intent to defraud, hinder,
or delay a creditor, and or
» or was created for or on behalf of an
antecedent debt » the value of consideration received or
obligation incurred by the debtor was
» when the debtor was insolvent less than equivalent value, and the
debtor
» on or within 90 days preceding the › was or became insolvent,
debtor’s bankruptcy filing date, and › had unreasonably small capital,
up to one year for an insider › and incurred debts beyond its
ability to pay at maturity
» and gave the creditor more than he
would have received in a Chapter 7
liquidation
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15. In either case, the issue of solvency is contested using the balance sheet,
adequate capital and cash flow tests
Balance sheet test
Is the value of the firm’s assets greater than the sum of
the value of its liabilities?
Adequate capital test
Does the firm have adequate capital to finance daily
operations and service its debt under typical economic
and financial circumstances?
Cash flow test
Is cash flow sufficient to retire debts as they fall due
given the firm’s past results, economic conditions, and
future opportunities?
17. Summary
» While a firm may be considered legally distinct from its owners, courts will
pierce the corporate veil to prevent fraud, achieve equity or preclude the
violation of a statute or public policy
» In piercing the corporate veil, courts employ tests under theories of alter ego,
instrumentality and equity
» Alter ego is based on the belief that if a firm’s owners disregard its
separateness, its separateness should also be disregarded to protect creditors,
while the theory of instrumentality is that a dominant entity should be
accountable for using a subservient entity for its own purposes
» Courts not satisfied with the theories of alter ego and instrumentality have
pursued tests under theories of equity, focusing on case specific facts
» Factors indicative of alter ego and instrumentality are those that demonstrate
financial dependence, identity confusion, lack of separateness, and control and
domination
» The indicia of alter ego are characteristic of preferential and fraudulent
transfer claims in bankruptcy litigation
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19. Boris J. Steffen, CPA, ASA, ABV, CDBV
(202) 538 – 5037
boris.steffen@naviganteconomics.com
» Boris Steffen is an expert in financial and managerial accounting, corporate finance and valuation
with significant multi-industry, multi-company and cross-border experience in operations, finance,
strategy and litigation. As an advisor in financing, investment and restructuring transactions and
claims, matters in which he has consulted or testified include antitrust and competition policy,
bankruptcy, restructuring and solvency, contracts, intellectual property, international trade and
arbitration, mergers and acquisitions, business valuation, pricing, costs and profitability, securities
and taxes.
» As a corporate development executive and consultant, Mr. Steffen has advised in transactions and
claims valued in excess of $100 billion. Sectors in which he has consulted include the aerospace,
automotive, beef processing, biotechnology, business services, cable network, chemical, consumer
product, defense, document management, electronic imaging, financial services & banking, food &
beverage, healthcare, independent power, information technology, insurance, internet, newspaper,
magazine, pharmaceutical, oil & gas, printing, pumps & controls, retail, satellite radio,
semiconductor, software, steel, telecom, tobacco and electric utility industries.
» Mr. Steffen has held positions in finance, public policy, corporate development and consulting with
Inland Steel Industries, the FTC, Bureau of Competition, U.S. Generating, and LECG. He holds a
Master of Management degree with specializations in accounting and finance from the Kellogg
School of Management of Northwestern University, and a Bachelor of Science degree in Finance and
Bachelor of Music degree in Applied Music from DePaul University. He is an Accredited Senior
Appraiser, Certified Public Accountant, Accredited in Business Valuation, Certified Distressed
Business Valuation Analyst, and member of the AICPA, ABA, ABI, Insol International, AIRA, ASA
and American Finance Association.
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20. Piercing the Corporate Veil
Boris J. Steffen, CPA, ASA, ABV, CDBV
Principal & Director
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