A corporation is a separate legal entity. This status normally insulates its owners or shareholders from personal liability for the obligations of the corporation. But Texas law recognizes exceptions to this general rule. Notably, Texas courts will pierce the corporate veil, i.e. look through the corporate body and hold the shareholder/owner liable, where a litigant demonstrates that piercing the veil is appropriate.
In Texas, alter ego, or piercing the corporate veil, is not an independent cause of action, but rather a means of imposing liability for an underlying cause of action. Vicarious liability, where applicable, allows a plaintiff to pierce an entity’s “corporate veil” and hold the entity’s shareholders, directors and officers individually liable for the entity’s obligations. That is, courts will disregard the corporate fiction “where the corporate form has been used in a fundamentally unfair arrangement to achieve an unfair result.”
Although it is a “fundamental principle” of company law that an individual may incorporate a company and thus generally protect themselves from personal liability for the company’s contractual obligations, courts have recognized that drilling alter ego veiling may be appropriate when not otherwise prohibited by law and (1) when a corporation is organized and operated as a mere tool or business conduit of another, (2) it exists such a “unity between society and individual that the separation of society has ceased”, and (3) holding only the society or individual accountable would result in injustice.
In order to impose liability on a shareholder or affiliate of the corporation, a plaintiff must show that the shareholder or affiliate caused the corporation to be used for the purpose of perpetuating and perpetrated actual fraud. on the creditor for the direct personal benefit of the Affiliate Shareholder.
Historically, courts have based alter ego findings on certain categories of evidence, including: (1) payment of alleged debts of a corporation by personal checks or other commingled funds, (2) statements that the individual will support the company financially, (3) diversion of company profits to the individual for personal use, (4) inadequate capitalization, and (5) failure to segregate company assets and personal assets.
History of piercing the corporate veil in Texas
In 1986, the Texas Supreme Court in Castleberry vs. Branscum established a broad doctrine piercing the veil, stating that incorporation normally shields shareholders, officers, and directors from liability for corporate obligations, “but where such persons abuse corporate privilege, the courts ignore the corporate fiction and hold them individually accountable.” The Court said that:
We disregard social fiction, even if social formalities have been observed and social and individual goods have been separated, where the social form has been used in a fundamentally unfair device to achieve an inequitable result. Specifically, we disregard corporate fiction:
(1) where fiction is used as a means to perpetrate fraud;
(2) where a company is organized and operated as a mere tool or business conduit of another company;
(3) where the corporate fiction is used as a means of circumventing an existing legal obligation;
(4) when the corporate fiction is used to obtain or perpetuate a monopoly;
(5) when the corporate fiction is used to circumvent any law; and
(6) when corporate fiction is invoked as protection against crime or to justify harm.
In Castleberrythe Texas Supreme Court recognized that Texas courts had long held that a corporation’s separate existence could, in certain circumstances, be ignored as a matter of equity and its responsibilities imposed on shareholders, officers, or directors individually where the corporate form or “fiction” was found to have been used as a “sham” to perpetrate “fraud” or to “evade an existing legal obligation”, or where the company was allegedly organized and operated as a mere “tool” or “commercial conduit” of another person, i.e. an “alter ego”.
The Texas Legislature, however, later restricted the doctrine when, in 1989, it amended the TBOC’s predecessor to protect shareholders, underwriters, and owners of a beneficial interest in the shares from contractual obligations of the corporation. .[1] Although the Texas Legislature restricted the otherwise broad veil-piercing doctrine, it maintained the doctrine that the person caused the corporation to commit actual fraud primarily for the direct personal benefit of the person.
The legislator amended the law again in 1993[2] and 1997, expanding the scope of the law’s protection. The legislature extended the law’s protective reach to “affiliates,” a defined term, protecting those who control the company even if they had no interest in the company.
Despite these legislative forays into the doctrine, the Texas Supreme Court has since referred to “types of abuse, specifically identified, that the corporate structure should not protect: fraud, evasion of existing obligations, circumvention of laws, monopolization , criminal conduct and the like. “Such abuse,” he warned, “is necessary before disregarding the existence of a company as a separate entity.”
Pierce the corporate veil under the TBOC
Under the TBOC, generally, a shareholder, beneficial owner, subscriber or affiliate cannot be held personally liable for (i) contractual obligations of the company based on a theory of alter ego or fraud, or (ii) other obligations based on non-compliance with social formalities. However, a court may disregard this liability protection and lift the corporate veil when:
- The shareholder, beneficial owner, underwriter or affiliate of the company used the company to perpetrate an actual fraud against the creditor,
- The fraud was perpetrated primarily for the direct personal benefit of the shareholder, beneficial owner, subscriber or affiliate
Therefore, an alter ego theory can be used to pierce the corporate veil and establish individual liability in a claim arising from a corporate contractual obligation, but only if the actual fraud was perpetrated primarily for the direct personal benefit of the individual.
Although the TBOC does not define the phrase “primarily for direct personal benefit”, Texas cases in which direct personal benefit has been satisfied involve funds from allegedly fraudulent corporate conduct that have been pocketed or diverted to the individual defendant.[3]
While the Texas Legislature has restricted the use of veil piercing principles in the absence of particular factors, other legal theories may allow a plaintiff to recover in the same way. For example, even where the protective statute prohibits liability that might otherwise be imposed under the common law, the statute provides no protection against liability imposed by another statute.
[1] Prior to 1989, Section 2.21 of the Texas Business Corporation Act provided that the liability of shareholders of a Texas corporation was limited to the value of their shares and did not mention any exception by which they could be held individually liable for the obligations of the corporation. society. . See Law of May 12, 1989, 71st legislature, RS, c. 217, § 1, 1989 Texas General Laws 974, 974–75. Notwithstanding this statutory language, courts in Texas, like those in sister states, have long held that a corporation’s separate existence could in certain circumstances be ignored as a matter of equity and its responsibilities imposed on shareholders, officers or directors individually.
[2] The legislature has provided that a shareholder’s liability for contractual obligations or related matters under section 2.21″[wa]s exclusive and prevails over any other liability imposed…under common law or otherwise. Law of May 7, 1993, 73rd Leg., RS, c. 215, § 2.05, 1993 Tex. Gen. Laws 418, 446.
[3] See Simplified Dev Corp. against GarfieldNo. 14-06-00526-CV, 2008 WL 399433, at *5-6 (Tex. App.—Houston [14th Dist.] February 14, 2008, pet. denied) (op. mem.) (defendant falsely told plaintiff that plaintiff would receive stock options in defendant’s company, but the stock was retained entirely by defendant; evidence legally sufficient to show that the individual defendant was “the primary beneficiary of the fraudulent conduct” when the defendant later sold five percent of the business for $1 million); Farr vs. Sun World Sav. Ass’n810 SW2d 294, 297-98 (Tex. App.—El Paso 1991, no writ) (interpreting the statutory predecessor to s. defendant was intended to provide a direct personal benefit to him” when defendant used company funds to pay his personal loans to purchase stock); see also TransPecos Banks vs. Strobach487 SW3d 722, 736 (Tex. App.—El Paso 2016, no. pet.) (affirming summary judgment denying bank’s attempt to pierce corporate veil; court noted absence of evidence that shareholder distributed the assets of the company to itself or to someone else); Solutioners Consulting, Ltd. against Gulf Greyhound Partners, Ltd.237 SW3d 379, 388 (Tex. App.—Houston [14th Dist.] 2007, no pet.) (legally insufficient evidence to support jury’s alter ego finding where evidence did not show that fraudulently withheld or misappropriated payments were “deposited…in [defendant’s] own personal account or used … to purchase personal items or pay personal debts”); Bates v. by TournillonNo. 07-03-0257-CV, 2006 WL 265474, at *3 (Tex. App.—Amarillo February 3, 2006, pet. no.) (op. memorandum) , the court noted, inter alia, the absence of evidence that the individual defendant “personally made any use of the items” he removed from the business).
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