Protection from personal liability is a valuable benefit of organizing a business under certain forms, such as limited liability companies (LLCs) or corporations. Generally, shareholders and directors aren’t at risk of personally paying for the corporation’ liabilities or debts.
However, that protection is not iron-clad. A legal doctrine called “piercing the corporate veil” allows creditors and claimants to hold shareholders and directors personally liable in certain situations. Given the high-stakes nature of these claims, it’s important for businesses to understand the basics of this doctrine—and how shareholders and directors can avoid exposing themselves to personal liability.
Grounds for Piercing the Corporate Veil
Oregon has one of the better articulated tests for determining when the corporate form can be disregarded to impose liability on individual shareholders, a test first set out in Amfac Foods, Inc. v. Int’l Systems & Controls Corp., 294 Or 94 (1982).
The Amfac criteria are:(1) The shareholder must have controlled the corporation; (2) the shareholder must have engaged in improper conduct in his exercise of control over the corporation; and (3) the shareholder’s improper conduct must have caused plaintiff’s inability to obtain an adequate remedy from the corporation.
Oregon courts may impose personal liability on corporate shareholders in situations involving:
- Actual Control of the Improper Conduct: When the shareholder has control of both the company and the improper conduct, and the improper conduct deprives the plaintiff of the ability to recover from the business itself.
- “Milking”: Where shareholders pay themselves more dividends than warranted, or improperly transfer business assets to themselves. For example, shareholders have been held liable for a corporation’s debts because they have milked a corporation by the payment of excessive dividends, by the sale of products to the shareholders at a reduced price, or by exacting unreasonable management charges.
- Commingling of Assets: Where shareholders fail to keep their personal and business assets and accounting separate. There must be such a commingling of property rights or interests as to render it apparent that they are intended to function as one, and that continuing to regard them as separate would aid the consummation of a fraud or wrong upon others.
- Gross Undercapitalization: A failure to initially capitalize the business with sufficient resources to cover foreseeable risks and operating costs. Although there is no statutory minimum capitalization requirement in Oregon, a corporation must have sufficient capital to cover its reasonably anticipated liabilities. Sufficiency of capital is measured at the time a corporation is formed and begins operations.
Another ground—failure to observe corporate formalities—involves the absence of regular meetings, formal resolutions, and the like. However, this conduct is rarely enough on its own to warrant piercing the corporate veil. Typically, failure to observe corporate formalities is used as additional evidence of a failure to keep the business entity separate from personal dealings.
Last, but not least, to be held liable on a theory of corporate disregard, there must be some causal link between a shareholder’s misconduct and the creditor’s harm, commonly described as “proximate cause”.
Avoiding Your Exposure to Personal Liability
Piercing the corporate veil is a highly nuanced undertaking. Oregon case law surrounding the details of this doctrine is murky and frequently evolving. Avoiding exposure to personal liability is an ongoing concern that starts with proper business formation and continues with smart corporate governance and record keeping. Before assuming that your corporation will always protect you from personal liability, shareholders should consult with a knowledgeable business attorney to avoid common mistakes and pitfalls that lead to personal liability by piercing the corporate veil.