Alter Ego / Single Business Entity in Texas
Limited Liability & Piercing The Corporate Veil
Limiting personal liability is one of the most defining aspects of a corporation or LLC, and can shield shareholders, directors, or officers from the debts and liabilities of a business. Though various business entities may provide liability protection in different forms and through different means, no corporate status makes owners and members impenetrably immune from all liability.
As is well known in Texas, the corporate veil can be pierced.
At Hendershot & Cowart, P.C., our award-winning trial lawyers leverage over a century of collective experience to counsel clients on a range of proactive and responsive legal needs. From entity selection and business formation to litigating complex and high-stakes claims, we help clients protect their rights and interests, and the future of their companies.
Corporate Owner, Director & Shareholder Liability
Though corporate status generally insulates officers, directors, and shareholders from liability for corporate obligations and debts, it does not grant them immunity.
In some cases – particularly those where individuals abuse the corporate privilege – Texas courts may disregard the “corporate fiction” and hold company owners, officers, or directors individually liable. This is known as piercing the corporate veil.
Though Texas Courts previously provided Plaintiffs a number of ways to hold owners of business entities liable, a Texas Supreme Court decision in 1986 (Castleberry) resulted in the Texas legislature limiting Plaintiffs’ abilities to hold corporate owners liable.
Today, corporate owners, directors, and officers in Texas can be held liable for corporate obligations if it can be proven that they used the corporation for the purpose of perpetrating (and did perpetrate) an actual fraud for their personal benefit.
Piercing the Corporate Veil in Texas
In Texas, there are two prevailing methods for piercing the corporate veil:
- Alter ego; and
- Single business entity.
Many corporate veil piercing cases have long been based on the alter ego theory, which involves a court’s disregard for the corporate entity and its liability protection when the individual and the corporation cease to be separate, and when holding solely the corporation liable would promote injustice. The corporation, in essence, functions as an individual’s alter ego to aid them in evading obligations or accountability.
In determining whether the alter ego theory applies, courts can evaluate the total dealings between shareholder and corporation, as well as evidence that may include:
- Whether corporate formalities have been followed and to what degree;
- Whether corporate and individual property have been kept separate and to what degree;
- Amount of financial interest, ownership, and control the individual has over the company;
- Whether the corporation has been used for personal purposes.
While Courts can consider these factors, Texas statute holds that owners cannot be held liable for obligations of the corporation based on failure to observe corporate formalities (Texas BOC § 21.223(a)(3)), nor for matters arising from or related to contractual obligations.
It is, in fact, often easier to pierce the corporate veil in tort actions and matters of statutory liability than it is in contract claims. However, owners / officers may still be liable for contract actions if they used the corporation for the purpose of perpetuating an actual fraud for their personal benefit.
Single Business Entity
The single business enterprise theory may be used to impose joint liability on separate entities. In Texas, this applies when a corporation is structured and organized in such a manner that it functions merely as an adjunct, tool, or business conduit of another corporation (i.e. they have centralized control, shared finances, and mutual purpose).
Because Texas Courts have held that a corporation cannot be liable for another’s debts solely because of centralized control and mutual purpose, Plaintiffs must prove abuse of the corporate structure, such fraud, evasion of obligations, criminal conduct, monopolization, etc. The two primary considerations in these claims, therefore, are: (1) the relationship between the two corporate entities; and (2) whether their use of limited liability was a fraud.
In determining whether corporations did or did not maintain separate entities, courts may consider factors such as:
- Common or centralized offices, employees, accounting, or business name;
- Wages paid by one corporation to another corporation’s employees;
- Services rendered by one corporation’s employees on behalf of another corporation;
- Undocumented transfers between corporations (including fraudulent conveyance);
- Unclear profit / loss allocation between corporations.
Proving Fraud to Pierce the Veil
Both the alter ego and single business enterprise theories are premised on concepts of justice and fairness.
Under Article 2.21 of the Texas Business Corporation Act (TBCA), for example, shareholders or affiliates cannot be held liable for a corporation’s contractual obligations unless they caused the corporation to be used to perpetrate “an actual fraud… primarily for the purpose of personal benefit”. Prior to this, Plaintiffs needed only to prove constructive fraud to prove a sham to perpetrate fraud.
As such, Plaintiffs must meet high standards to pierce the corporate veil, namely, proving actual fraud. This might involve proving:
- Dishonesty of purpose or intent to deceive;
- Fraudulent misrepresentation;
- Fraudulent conveyance;
- Failure to disclose material facts.
In addition to proving actual fraud, Plaintiffs must also prove fraud was perpetrated “primarily for the direct personal benefit” of the owner / officer. Most cases where this is met involve evidence which shows that funds from the corporation’s allegedly fraudulent conduct were diverted or pocketed by the individual defendant. Showing that funds were used for the corporation’s benefit is generally insufficient.
Texas law does not specify that liability based upon alter ego or other veil-piercing theories must be accompanied by actual fraud if the underlying claim is based upon a tort or statutory liability that does not arise out of a contract of the corporation. However, Plaintiffs pursuing such claims will still need to cultivate evidence and convincing arguments in order to prevail.
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Because Texas is a business-friendly state that values the entrepreneurial spirit, bringing and winning claims of alter ego and single business entity can be an uphill task. Whether you are attempting to pierce the corporate veil, need to defend against litigation, or want to ensure adequate protections from the inception of your new business, experienced counsel and representation is vital.
At Hendershot Cowart, P.C., our award-winning Texas attorneys are available to discuss your need, rights, and options during a confidential consultation. Call or contact us online to speak with a lawyer.