Emory Law Journal
Veil-piercing is the most heavily litigated issue in corporate law, yet legal doctrine in this area is notoriously incoherent. In this article, I argue that the only way to make sense of veil-piercing is through an accurate understanding of the policy underlying limited liability. Once that is appreciated it then becomes possible to make sense of the appropriate limits on limited liability. Piercing the corporate veil can then serve the useful function of distinguishing legitimate from illegitimate reliance on statutory limited liability.
After surveying efficiency rationales for limited liability and finding them unpersuasive, I propose that the best way to understand the purpose of limited liability is as a subsidy designed to encourage business investment. The subsidy comes at the expense of corporate creditors. It is easy to see how this is so as to victims of corporate torts; limited liability requires that they bear their losses to the extent they exceed corporate assets. It is less obvious that shareholders actually gain value from contract creditors, who can insist on compensation ex ante for increased risk of default, but even in this context I argue that recent research in behavioral economics suggests that shareholders do benefit at creditors' expense from the statutory limited liability default rule.
However beneficial the limited liability subsidy may be to corporate shareholders and to society more generally, it should not be so broad as to encompass illegitimate behavior. In particular, limited liability should not provide the occasion for shareholders to behave opportunistically toward corporate creditors. As to contract creditors, that means transfer of risk that creditors have not agreed to bear, as, for example, when controlling shareholders cause a corporation to incur a debt having no reasonable basis for believing that it will be repaid. As to both contract and tort creditors, the key concern is use of limited liability as a device deliberately or recklessly to extract value from third parties without their consent and without compensation; absent the limited liability shield, such practices could not be effective because business owners would bear full responsibility for creditor claims. Fairness and efficiency considerations - especially the higher cost of credit for all corporate borrowers - necessitate denial of limited liability in cases of opportunism because the subsidy to investors comes at too great a cost to corporate creditors.
Limited liability should instead be limited to situations in which shareholders have managed the business with due regard for bargained-for expectations and potential victims of reasonably foreseeable accidents. If corporate insolvency has occurred despite the shareholders' reasonable efforts to manage the business in a financially responsible manner, the limited liability shield should protect them. If restricted to cases of financial responsibility, limited liability would still protect shareholders from the kinds of losses that should be their primary concern, namely business insolvency due to causes could not reasonably have been anticipated or prevented. As such, limited liability would still facilitate corporate law's business subsidization policy, but the cost of that subsidy would be reduced to an amount that respects legitimate creditor and societal interests.
David K. Millon, Piercing the Corporate Veil, Financial Responsibility, and the Limits of Limited Liability, 56 Emory L. J. 1305 (2007).