High Court Invited to Peak Behind Corporate Veil

“Piercing the corporate veil” may sound like a title for a summer thriller novel within a business setting. In legal reality, however, it is a potential horror story in which no business owner would ever wish to be a character.

What happens in a piercing of the “corporate veil” is that a court looks through the corporate entity to find the owners liable for the obligations of the entity. The veil of corporate identity protecting them is ripped away.

Last October, the Court of Special Appeals of Maryland considered piercing the corporate veil of a company that was being sued for payment on a contract; but ultimately, the court declined to do so. One reason for the outcome was that the state’s highest court, the Court of Appeals, had yet to define in workable detail one of the terms under which piercing could occur under Maryland case law. Nevertheless, the case serves as a caution to business owners, especially if the high court eventually finds a case in which to take up the invitation from the Court of Special Appeals to provide more specifics on the veil-piercing standard.

The plaintiff in the case was engaged to handle a billing dispute that a company was having with its telephone service provider. In the midst of the work, the company that engaged the plaintiff dissolved upon a merger into a shell company owned by a parent company, thereby becoming a wholly owned subsidiary of the parent.

When disputes arose over terms of payment to the plaintiff, the plaintiff sought to pierce the corporate veil of the subsidiary in order to collect payment from the parent company. The plaintiff argued, among other things, that the piercing was necessary because the parent exercised extensive control over the subsidiary. The trial court ruled against the plaintiff. On appeal to the Court  of Special Appeals, the court affirmed the standard from a 1975 case setting forth the reasons for piercing the corporate veil; specifically: (i) proof of fraud; or (ii) the need to enforce a “paramount equity”; that is, a fundamental fairness.

In its analysis, the court found no fraud in the merger scheme; the surviving subsidiary remained liable for any fees owed to the plaintiff. As for the need to enforce a “paramount equity”, the court declined to apply that concept in the case, citing the lack of specific guidance under Maryland case law as to the meaning of “paramount equity”. Citing one of its earlier cases, the court said that “the Court of Appeals to date has not elaborated upon the meaning of this phrase or applied it in any case of which we are aware.” Thus, the court reasoned: “Without any precedent approving this extraordinary remedy, we decline to pierce the corporate veil of [the new subsidiary company] to impose liability on [the parent company] based on the paramount equity justification.”

In its argument, the plaintiff asked the court to look beyond the Maryland case law standard for piercing the corporate veil to accept a separate analysis applied in some other states, namely, “instrumentality”. Under this concept, the piercing is justified on account of the business owner failing sufficiently to differentiate between the identity and assets of the owner and the corporation; for example, total dominance by a parent of a subsidiary, non-functioning officers and directors, mingling of personal and corporate accounts, failure to observe corporate formalities and otherwise allowing the corporate to exist as a mere alter ego of the owner.

The Maryland court, however, declined to expand the piercing analysis. “Maryland is more restrictive than other jurisdictions in applying the doctrine,” the court said. The instrumentality theory “is not a basis to pierce the corporate veil in Maryland.”

Although the court did not pierce the corporate veil in this case, the fact that it was asked to do so, and that it invited the Court of Appeals to advise how piercing might be done in the future under the “paramount equity” concept, suggests that Maryland companies ought to ensure that business identity is clearly delineated. Here is a checklist of basic, though not comprehensive, measures to consider:

-- Observe all corporate formalities, such as meetings of stockholders and directors, and documentation of those meetings in detailed minutes;

-- Officers and directors should actively carry out their appointed duties;

-- Ensure complete separation of corporate accounts and any personal accounts of officers, directors and stockholders, and adequate capitalization of the business;

-- Documentation of officer loans as such; and

-- Maintenance of corporate records, including updated bylaws, stock ledger and payment of corporate personal property taxes.

For more information please contact Jay Merwin at 410-583-2400 or merwin@bowie-jensen.com.