How many lenders have heard this line: “The corporation is bankrupt. There is nothing left.” These words can prove devastating to an unsecured (or under-secured) lender. The words are particularly troubling where there is no personal guaranty from the owners of the insolvent corporation.

However, there exists one final (and potentially rewarding) option for such lenders: an attempt to “pierce the corporate veil.” Much like the often misunderstood “non-compete” agreements in employment law, there exists a misconception among lenders that it is “impossible” to pierce the corporate veil. While Courts generally do not pierce the corporate veil to hold a principal, parent or related corporation liable, there exist circumstances in which Courts can, and do, impose such liability.

Though each case is driven by its particular facts, there are a number of factors that Courts will generally consider in determining whether to pierce the corporate veil. Some of those factors include:  (1) gross undercapitalization; (2) failure to observe corporate formalities; (3) non-payment of dividends; (4) insolvency of the debtor corporation; (5) siphoning of funds by the dominant shareholder; (6) nonfunctioning of other officers and directors; (7) absence of corporate records; and (8) the fact that the corporation is a mere façade for the operations of the dominant stockholder. Essentially, where there is evidence that the entity’s owners abused the legal separation and used the corporate entity for improper purposes, the veil will be pierced.  These factors are particularly prevalent in closely held businesses.

Lenders should closely examine whether there is a basis to consider a claim in an effort to pierce the corporate veil and pursue the assets of an owner or related entity. Such claims, though complex and often costly, can, in the right circumstances, result in substantial assets being made available to lenders who would otherwise receive little or no repayment. Further, the mere threat of such a claim may raise significant concerns in the eyes of a debtor, who may be more willing to negotiate an amicable resolution, lest evidence of a disregard of corporate formalities be exposed.

Rhoads & Sinon regularly represents financial institutions in all aspects of Business and Banking Litigation. For more information, contact Robert J. Tribeck, Esquire at 717.237.6701 or rtribeck@rhoads-sinon.com.