A corporation is a separate legal entity. This status normally insulates its owners or shareholders from personal liability for the corporation’s obligations. But Texas law recognizes exceptions to this general rule. Notably, Texas courts will pierce the corporate veil—that is, look through the corporate entity and hold the shareholder/owner liable—where a litigant demonstrates that veil piercing is appropriate.
What is Piercing the Corporate Veil?
In Texas, alter ego, or piercing the corporate veil, is not an independent cause of action, but is instead a means of imposing liability for an underlying cause of action. Alter ego liability—where applicable—permits 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 “when the corporate form has been used as part of a basically unfair device to achieve an inequitable result.”
While it is a “bedrock principle” of corporate law that an individual can incorporate a business and thereby generally shield himself from personal liability for the corporation’s contractual obligations, courts have recognized that alter ego veil piercing may be appropriate where it is not otherwise barred by statute and (1) where a corporation is organized and operated as a mere tool or business conduit of another, (2) there is such “unity between corporation and individual that the separateness of the corporation has ceased,” and (3) holding only the corporation or individual liable 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 an actual fraud on the obligee for the direct personal benefit of the shareholder of affiliate.
Historically, courts have based alter ego findings on certain categories of evidence, including: (1) the payment of alleged corporate debts with personal checks or other commingling of funds, (2) representations that the individual will financially back the corporation, (3) the diversion of company profits to the individual for the individual’s personal use, (4) inadequate capitalization, and (5) the failure to keep corporate and personal assets separate.
History of Piercing the Corporate Veil in Texas
In 1986, the Texas Supreme Court in Castleberry v. Branscum established a broad veil piercing doctrine, stating that incorporation normally protects shareholders, officers, and directors from liability for corporate obligations, “but when these individuals abuse the corporate privilege, courts will disregard the corporate fiction and hold them individually liable.” The Court stated that:
We disregard the corporate fiction, even though corporate formalities have been observed and corporate and individual property have been kept separately, when the corporate form has been used as part of a basically unfair device to achieve an inequitable result. Specifically, we disregard the corporate fiction:
(1) when the fiction is used as a means of perpetrating fraud;
(2) where a corporation is organized and operated as a mere tool or business conduit of another corporation;
(3) where the corporate fiction is resorted to as a means of evading an existing legal obligation;
(4) where the corporate fiction is employed to achieve or perpetrate monopoly;
(5) where the corporate fiction is used to circumvent a statute; and
(6) where the corporate fiction is relied upon as a protection of crime or to justify wrong.
In Castleberry, the Texas Supreme Court recognized that Texas courts had long held that a corporation’s separate existence could in certain circumstances be disregarded as a matter of equity and its liabilities imposed on shareholders, officers, or directors individually when the corporate form or “fiction” was deemed to have been used as a “sham” to perpetrate “fraud” or to “evade an existing legal obligation,” or when the corporation was said to have been organized and operated as a mere “tool” or “business conduit” of another person, i.e., an “alter ego.”
The Texas legislature, however, subsequently narrowed the doctrine when, in 1989, it amended the TBOC’s predecessor to protect shareholders, subscribers, and owners of a beneficial interest in shares from the corporation’s contractual obligations.[1] Although the Texas legislature narrowed the otherwise broad veil piercing doctrine, it maintained the doctrine where the person caused the corporation to commit actual fraud primarily for the person’s direct personal benefit.
The legislature amended the statute again in 1993[2] and 1997, expanding the scope of the statute’s protection. The legislature extended the statute’s protective reach to “affiliates,” a defined term, shielding those in control of the corporation even if they had no ownership interest in the corporation.
Despite these statutory inroads on the doctrine, the Texas Supreme Court has since referred to “the kinds of abuse, specifically identified, that the corporate structure should not shield—fraud, evasion of existing obligations, circumvention of statutes, monopolization, criminal conduct, and the like.” “Such abuse,” it has cautioned, “is necessary before disregarding the existence of a corporation as a separate entity.”
Piercing the Corporate Veil under the TBOC
Under the TBOC, generally a shareholder, beneficial owner, subscriber or an affiliate cannot be held personally liable for the corporation’s (i) contractual obligations based on a theory of alter ego or fraud, or (ii) other obligations based on a failure to observe corporate formalities. However, a court may disregard this protection against liability and may pierce the corporate veil where:
- The corporation’s shareholder, beneficial owner, subscriber, or affiliate used the corporation to perpetrate an actual fraud against the obligee,
- The fraud was perpetrated primarily for the direct personal benefit of the shareholder, beneficial owner, subscriber, or affiliate
As a result, an alter ego theory can be used to pierce the corporate veil and establish individual liability in connection with a claim arising from a corporate contractual obligation, but only if actual fraud was perpetrated primarily for the direct personal benefit of the individual.
While the TBOC does not define the phrase “primarily for the direct personal benefit,” Texas cases in which the direct personal benefit showing has been met involve funds derived from the corporation’s allegedly fraudulent conduct that were pocketed by or diverted to the individual defendant.[3]
While the Texas legislature has curtailed the use of veil piercing principles in the absence of particular factors, other legal theories may allow a plaintiff to recover in a similar manner. For instance, even when the protective statute bars liability that otherwise might be imposed under the common law, the statute provides no protection from liability imposed by another statute.
Need assistance in managing the business planning processes? Freeman Law advises clients with corporate and other entity formations and reorganizations. Restructuring entities—through conversions, mergers, and liquidations—can involve particularly complex tax and regulatory considerations. Freeman Law provides experienced tax and business counsel, helping our clients achieve their organizational goals in a tax-efficient manner. Schedule a consultation or call (214) 984-3000 to discuss your corporate structuring or business and tax planning concerns.
[1] Prior to 1989, article 2.21 of the Texas Business Corporation Act mandated that the liability of shareholders in a Texas business corporation was limited to the value of their shares and made no mention of any exception through which they could be held individually liable for the corporation’s obligations. See Act of May 12, 1989, 71st Leg., R.S., ch. 217, § 1, 1989 Tex. Gen. Laws 974, 974–75. This statutory language notwithstanding, Texas courts, like those of sister states, had long held that a corporation’s separate existence could in certain circumstances be disregarded as a matter of equity and its liabilities imposed on shareholders, officers, or directors individually.
[2] The Legislature provided that liability of a shareholder for contractual obligations or related matters under then-article 2.21 “[wa]s exclusive and preempts any other liability imposed … under common law or otherwise.” Act of May 7, 1993, 73d Leg., R.S., ch. 215, § 2.05, 1993 Tex. Gen. Laws 418, 446.
[3] See Simplified Dev. Corp. v. Garfield, No. 14-06-00526-CV, 2008 WL 399433, at *5-6 (Tex. App.—Houston [14th Dist.] Feb. 14, 2008, pet. denied) (mem. op.) (defendant misrepresented to plaintiff that plaintiff would receive stock options in defendant’s company, but stock was wholly retained by defendant; evidence legally sufficient to show individual defendant was “the primary beneficiary of the fraudulent conduct” where defendant later sold five percent of company for $1 million); Farr v. Sun World Sav. Ass’n, 810 S.W.2d 294, 297-98 (Tex. App.—El Paso 1991, no writ) (interpreting section 21.223’s statutory predecessor, court concluded the evidence was legally sufficient to show individual defendant’s “actual fraud was intended to provide a direct personal benefit to him” where defendant used company funds to pay his personal stock purchase loans); see also TransPecos Banks v. Strobach, 487 S.W.3d 722, 736 (Tex. App.—El Paso 2016, no pet.) (upholding summary judgment denying bank’s attempt to pierce the corporate veil; court noted the absence of evidence that the shareholder distributed corporation’s assets to herself or anyone else); Solutioneers Consulting, Ltd. v. Gulf Greyhound Partners, Ltd., 237 S.W.3d 379, 388 (Tex. App.—Houston [14th Dist.] 2007, no pet.) (evidence legally insufficient to support jury’s alter ego finding where evidence did not show that fraudulently retained or misappropriated payments were “deposited … into [defendant’s] own personal account or used … to purchase personal items or pay personal debts”); Bates v. de Tournillon, No. 07-03-0257-CV, 2006 WL 265474, at *3 (Tex. App.—Amarillo Feb. 3, 2006, no pet.) (mem. op.) (reversing finding that corporate veil should be pierced, court noted, among other things, absence of evidence indicating the individual defendant “personally made any use of the items” he removed from the company).
