United States: Veil Piercing/Alter Ego Determinations – How Fund Managers Can Protect Themselves

A veil piercing claim can be a worst-case scenario for a private fund manager dealing with a struggling portfolio company investment – the company fails, and ensuing legal claims are brought not only against the portfolio company, but also against the fund and its GPs. How can fund managers manage that risk?

Limited liability is a hallmark of the corporate structure. Yet the legal doctrines of veil piercing and alter ego permit courts to "pierce" or bypass the corporate structure in order to hold shareholders and directors personally liable for a corporation's actions or debts. These doctrines have important implications in the context of a fund that owns large stakes in portfolio companies.

If a fund is found to be the alter ego of a portfolio company, the fund may be exposed to significant liabilities even in the absence of direct claims against the fund. For example, if a portfolio company falters and implements a large-scale layoff, there is a high likelihood that plaintiffs will file a WARN Act action. Outside investors or employee shareholders may pursue misrepresentation and fraud claims against the company based on rosy predictions. When the portfolio company is insolvent, plaintiffs will seek out the "deep pockets" of the fund itself on a veil piercing or alter ego theory.

This post outlines the general standards for veil-piercing under Delaware law and provides concrete steps that can help to limit the exposure of a fund and its managers to derivative liability claims. We chose Delaware law because of the state's popularity as a state of incorporation.

An important caveat: As we will discuss in a later post, California law differs in several important respects from Delaware law on this topic.

What Law Applies?

Most states, though not all, choose the law of the state of incorporation when considering veil-piercing claims under the "internal affairs doctrine." That doctrine generally states that the law of the state of incorporation (e.g. Delaware) controls the "internal affairs" of a corporation. So, for corporations organized in Delaware, even if a claim is brought in New York or Illinois, Delaware law will typically apply to the veil-piercing claims under the internal affairs doctrine. See, e.g., Fletcher v. Atex, Inc. (2d Cir. 1995) ("Under New York's choice of law rules, the law of the state of incorporation determines when the corporate form will be disregarded").

Why is this important? The law in Delaware (like New York and Pennsylvania) is regarded as particularly favorable to owners/managers resisting a veil-piercing claim. California, on the other hand, is typically considered an easier jurisdiction to pierce the veil. And rather than looking to the state of incorporation, California courts generally apply California law to alter ego claims, as we will discuss in a later post.

Another difference between states is whether veil piercing is treated as an equitable matter for the judge to decide or a factual question for the jury. In Delaware, for example, a judge decides veil-piercing claims. Texas is an outlier, where such claims are left to the jury.

These differences are important because choice-of-law determinations in veil piercing cases are, unlike in breach-of-contract lawsuits, not governed by a contractual provision; indeed, by definition no contract could exist between the plaintiff seeking to pierce the corporate veil and the parent corporation, otherwise there would be no need to pierce the veil. Instead, the applicable law will be determined by the choice-of-law provisions of the forum state. Most often, courts apply either the law of the state of incorporation of the entity subject to piercing or the law of the forum state.

General Standards in Delaware

Delaware law, which governs many veil piercing claims, provides robust piercing protections. A plaintiff seeking to pierce the corporate veil in Delaware needs to show that the corporation, through its alter-ego, has created a sham entity designed to defraud investors and creditors. In other words, Delaware requires a plaintiff to demonstrate "an element of fraud" or something like it. See, e.g., Winner Acceptance Corp. v. Return on Capital Corp., No. 3088-VCP, 2008 WL 5352063, at *5 (Del. Ch. 2008). This is a very high standard.

The veil-piercing analysis in Delaware, as in most jurisdictions, is fact-intensive. Delaware courts consider factors such as:

  1. whether the company was adequately capitalized for the undertaking;
  2. whether the company was solvent;
  3. whether corporate formalities were observed;
  4. whether the controlling shareholder siphoned company funds; and
  5. whether, in general, the company simply functioned as a façade for the controlling shareholder.

Due in large part to the fraud requirement, Delaware courts grant dismissal or summary judgment of alter ego claims with greater frequency than do the courts of many other jurisdictions.

What You Can Do

So, what can you do to protect a fund from piercing claims? We have put together a list of dos and don'ts to help minimize exposure to these types of claims.


  • Keep separate books and records for both companies.
  • Have separate meetings of the board and keep separate minutes.
  • Make the board composition of the entities different.
  • Keep separate accounts, including bank accounts, for both companies.
  • Require the use of separate email addresses and letterhead for any individuals with positions in both entities.
  • Where possible, maintain an arm's length relationship in business dealings between related entities.
  • Adequately capitalize any corporation for its line of business.


  • The two companies should not use the same office or business location.
  • They should not employ the same employees/attorney.
  • Do not divert assets from a corporation to the detriment of creditors, or manipulate assets and liabilities between entities so as to concentrate the assets in one and the liabilities in another. This is a potential sign of the fraud element that Delaware law requires for veil piercing to apply.
  • Do not have identical equitable ownership in the two entities, especially if the equitable owners have control over both entities.
  • Do not have the same directors and officers responsible for supervision/management of both entities.
  • Do not make the parent liable for the debts of the portfolio company.

Some of these suggestions are relatively fundamental and easy to implement. Others may be harder to accomplish, especially when managing a struggling portfolio company. Given the risks, it is important to try to follow these guidelines. If questions arise concerning the risk-reduction measures we've outlined above, it always makes sense to consult with outside counsel.

Veil Piercing/Alter Ego Determinations – How Fund Managers Can Protect Themselves

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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