Piercing the Corporate Veil in Texas

robind Business

Can you “pierce the corporate veil” in Texas?

You can, but “piercing the corporate veil” may not be as easy as you think. Plaintiffs often seek to “lift the corporate veil” to make corporate officers, directors, shareholders, or affiliated corporations individually liable for corporate debts or alleged wrongdoing, but it is not something that is often granted by the courts.

Why?

One of the primary purposes of creating an LLC, corporation, or holding company is to shield shareholders and other affiliated individuals from liability for poor business decisions, frivolous litigation, or other events that may be beyond their control and could cause financial ruin. If you are unable to collect the judgment you seek from an individual for an alleged corporate wrong, the system is working as intended.

This doesn’t mean that you can never pierce the corporate veil in Texas, but, before you can hold an individual liable for corporate debt or a corporate wrong, you must prove that 1) the individual or corporation you seek to hold liable committed actual fraud 2) for the direct personal benefit of the individual or corporation you want to hold liable.

Piercing the Corporate Veil – Castleberry and the Common Law

The older common law governing piercing the corporate veil in Texas was outlined by the Texas Supreme Court in Castleberry v. Branscum, 721 S.W. 2d 270 (Tex. 1986).

The Castleberry rule, which is now limited by § 21.223(a) of the Texas Business Organizations Code (see below), stated that courts would “disregard the corporate fiction” when “the corporate form has been used as part of a basically unfair device to achieve an inequitable result,” including:

  • When the corporation was used to perpetrate fraud,
  • Where the corporation was a mere tool or business conduit of another corporation,
  • When the corporation was used to evade an existing legal obligation,
  • When the corporation was used to achieve or perpetuate a monopoly,
  • Where the corporation was used to circumvent a statute, and
  • When the corporation was relied upon as a “protection of crime or to justify wrong.”

Alter Ego

One common theory used to pierce the corporate veil in Texas is “alter ego,” defined in Castleberry as “where a corporation is organized and operated as a mere tool or business conduit of another corporation.”

Factors that Texas courts may consider when deciding whether a corporation is simply an “alter ego” of another corporation or individual include:

  • Whether the corporation followed corporate formalities as required under Texas law,
  • Whether corporate and individual property have been kept separate or “commingled,”
  • The degree of the financial interest, ownership, and control that the individual has over the corporation, and
  • Whether the corporation is used to serve the individual’s personal uses.

Although these factors are still relevant, the “alter ego” theory is now limited by § 21.223(a) of the Texas Business Organizations Code (see below).

Single Business Enterprise

Like the “alter ego” theory, the “single business entity” theory seeks to impose liability on an affiliated corporation where the two corporations have centralized control and purpose and fall within one of the purposes listed in Castleberry – the affiliated corporation was used to commit fraud, avoid an existing legal obligation, or achieve a monopoly, for example.

Like the alter ego theory and the other theories identified in Castleberry, the single business entity theory is also limited by § 21.223(a) of the Texas Business Organizations Code.

So, what is the rule for piercing the corporate veil in Texas under § 21.223(a) of the Texas Business Organizations Code?

§ 21.223(a) of the Texas Business Organizations Code Requires Actual Fraud for Personal Benefit

Under § 21.223(a) of the Texas Business Organizations Code, the default rule is that the corporate veil will not be pierced.

A shareholder, owner, subscriber for shares, or any affiliate of a shareholder, owner, subscriber, or the corporation “may not be held liable to the corporation or its obligees with respect to:”

  1. Shares, apart from an obligation to pay consideration for shares,
  2. Any contractual obligation of the corporation on a theory of alter ego, actual or constructive fraud, sham to perpetrate fraud, or any similar theory, or
  3. The corporation’s failure to observe corporate formalities including formalities required by the Texas Business Organizations Code or the corporation’s bylaws.

So, when can the corporate veil be pierced in Texas?

  • 21.223(b) says that the corporate veil can be lifted only when:
  • The corporation or individual is an alter ego, committed fraud, or there is a similar theory as described in § 21.223(a)(2), and
  • The corporation or individual caused the corporation to be used for fraud and did perpetrate a fraud on the oblige, and
  • The fraud was “primarily for the direct personal benefit of the holder, beneficial owner, subscriber, or affiliate.”

This means that Castleberry and subsequent cases related to piercing the corporate veil are still relevant, but only when the individual 1) committed fraud and 2) the fraud was primarily for the direct personal benefit of the individual.

For example, the Fourteenth District Court of Appeals of Texas held last year in Mungas v. Odyssey Space Research, LLC, No. 14-19-00378-CV (Tex. App. Aug. 5, 2021) that the founder and sole owner of a corporation was not liable for the obligations of the corporation, finding that § 21.223 is “exclusive and preempts any other liability imposed for that obligation under common law or otherwise,” and that “[g]enerally, alter ego will not apply to disregard the corporate form absent exceptional circumstances.”

The courts have adopted Castleberry’s definition of “actual fraud” as “involving dishonesty of purpose or intent to deceive.” Even when actual fraud is proven, however, the party seeking to pierce the corporate veil must also prove that the defendant engaged in the fraud for their direct personal benefit.

In sum, the corporate veil can be pierced in Texas, but only in the rare case where the plaintiff proves that 1) actual fraud was committed and 2) the fraud was for the individual’s personal benefit.

Please feel free to contact one of our Murray Lobb attorneys to obtain our assistance in civil litigation. We also remain available to help you with all your general corporate, construction law, business, and estate planning needs.