Behind the corporate veil
- By Carl Peckinpaugh
- Jul 10, 2000
An important consideration in starting a business is whether to form it
as a corporation.
Organizing a business as a corporation offers many advantages. For example,
the ability to sell stock can be a significant help when raising capital.
Using a corporate form ordinarily will insulate the owners from direct liability
for the company's obligations, because the corporation is considered to
be a separate legal identity, independent of its owners.
But organizing a business as a corporation can have several disadvantages.
Most notably, using the corporate form can result in double taxation on
income. Because the corporation is an independent legal entity, it may be
required to pay income taxes on its profits. Then, when the proceeds are
distributed, the owners pay taxes on their own personal income.
Another disadvantage is accommodating the many rules imposed by state
laws. These "corporate governance" rules cover things such as board of directors
meetings, capitalization requirements and reporting requirements. Complying
with those procedural restrictions can reduce efficiency.
Still, it is crucial to follow those procedures. In some situations,
when a court believes that the owners have failed to comply with those rules,
it can hold the owners responsible directly for the obligations of the corporation.
This is called "piercing the corporate veil."
Different courts take somewhat different approaches to this issue, although
they typically end up in about the same place. Generally speaking, the corporate
form may be disregarded and the owners held directly liable when: the owner/parent
dominates the operations of the corporation/subsidiary; the arrangement
is used to commit a fraud or other wrong; and a third party is damaged as
This is more likely when the corporation/subsidiary has been undercapitalized
or when the owner/parent fails to keep proper records or otherwise fails
to observe corporate formalities.
In theory, the same rules apply to government contracting. In practice,
there is sometimes an even greater tendency to disregard the corporate
form in those situations.
Thus, for example, a corporation may be treated together with its affiliates
in determining whether it is a responsible contractor.
Also, all of the affiliates are taken together when determining whether
a company complies with applicable size standards. See, for example, Goff
Corp. Moreover, government agencies often seek to disregard the separate
nature of corporate entities when collecting contractor debts. See, for
example, National Security Service Co.
Although using a corporate form for doing business can provide many advantages,
investors who use this approach must be careful to follow the rules to maintain
—Peckinpaugh is corporate counsel for DynCorp, Reston, Va., and formerly
a member of the government contracts section for Winston & Strawn, Washington,