Corporate and Limited Liability Company (LLC) structures can be complicated and multi-layered, often formed that way for genuine business purposes. Occasionally, shareholders or directors with a nefarious intent seek to use those structures to try to protect themselves from liabilities.
But creditors or other claimants may be able to get redress through a legal doctrine known as “piercing the corporate veil,” which would put aside the limited liability of the corporation’s shareholders or directors and make them personally liable for the company’s actions or debts. This option is most relevant in bankruptcy and fraud cases.
Piercing the veil can be a vital tool to address wrongdoing by a company, but pursuing that path in a legal action can be a steep hill to climb. The bar is high for claimants seeking to remove that layer of protection established for corporations.
And that’s because, generally speaking, corporate shareholders and LLC members are not liable for their company’s debts. When these claims are successful, plaintiffs are entitled to payments from the owner or shareholder’s personal assets.
When there is no real separation between the corporation and the owners and directors, and it functions as an “alter ego” of those parties operating the business, a court may be inclined to pierce the corporate veil. The owners and directors aren’t entitled to the limited liability protection that a genuine corporate structure would provide when they have unscrupulously benefitted from their actions.
When a court is challenged to decide, based on the totality of the evidence, if the doctrine should be applied, they look at a broad range of factors. Some of those criteria are quite straightforward to discover, and some require a deeper investigation. Claims like the failure to maintain corporate records, a disregard for corporate formalities and the existence of non-functioning officers and directors may be uncovered fairly easily.
Benefits of forensic investigations
In other instances, forensic accountants can help attorneys determine if piercing the veil is a warranted strategy and work with them to develop the necessary arguments so it does makes sense in a lawsuit.
Here are an additional five areas where forensic accounting can be helpful when seeking to lift the veil on behalf of claimants:
1. Commingling of corporate and personal affairs
Sometimes an owner or major shareholder sets up multiple entities to move corporate funds around and draw on them for personal use.
When a company doesn’t have enough funds to stand on its own, it can become clear it wasn’t truly a separate entity. You may be able to see how an owner intentionally manipulated the funds that were there for their personal benefit.
3. Failure to pay dividends
When individuals who’ve invested in a company are not seeing any return, but the controlling shareholders or owners have figured out a way to pull money out.
You may be able to show that the owners or major shareholders stripped so much money out that there was nothing left when the creditors showed up and sought to be paid.
5. Use of the corporate entity to perpetrate fraud
It is very hard to prove fraud, but it’s an area where forensic accountants excel. It’s one of the most common factors laid out in state laws as acceptable grounds for piercing the veil.
This is not an exhaustive list of factors and not all of the mentioned factors need to be established to be successful in involving the doctrine. Some may simply not apply and even if they do, they may not be sufficiently demonstrated to a court.
The best approach is to focus on the strongest factors that emerge in your analysis and provide those to the court. The court looks at the totality of the evidence in determining if the corporate veil is to be pierced — and whether the personal assets of the shareholders or LLC members are to be reached by the injured party.
A forensic accountant can be a valuable resource to the litigating attorney attempting to use the doctrine. Persuasive analysis can help produce a valuable result. It’s important for the attorney and forensic accountant to work together closely to offer the most compelling scenario for a positive outcome.
How Wipfli can help
Wipfli litigation support consultants can work with attorneys and their clients to obtain redress in fraud or bankruptcy cases. Learn more about how our experienced forensic accounting consulting team can help uncover the compelling information you need for successful results.
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