Separation Anxiety: Veil Piercing, Alter Ego and the Bounds of Corporate Separateness
Hardly a week goes by without a client asking us: Can we sue the owners of a cannabis company personally for the company’s failure to pay our invoice / transfer us the license / sell us the land?
In other words, they are asking, “Can we pierce the corporate veil and access the owner’s individually owned assets to satisfy debts of the business?”
The short answer is no, usually not.
The intertwined principles of limited liability and corporate separateness generally shield owners, including cannabis company owners, from any liability for the company’s debts and obligations beyond whatever capital they have already invested. Judges love to say that piercing the veil is an “extreme” remedy and it very much is the exception and not the rule. And, though the distinction may seem subtle, veil piercing is not a standalone claim. Instead, it is a remedy. This means it is a mechanism by which a court effectuates a judgment the court has entered awarding damages and/or other relief to a party that prevails on a substantive claim, like fraudulent misrepresentation or conversion of assets by way of commingling.
So, you cannot go into court and merely ask the judge to pierce the corporate veil of a cannabis company. Instead, you have to assert and prevail on a substantive legal claim arising out of facts and circumstances that justify the court using the extreme remedy of veil piercing to facilitate a meaningful recovery. To make threading this needle even more challenging, a proponent of veil piercing generally must demonstrate that the complained-of harm results from disregard for corporate separateness–specifically such that the company and its owner are considered each other’s “alter ego.”
For example, there could be a good argument to pierce the veil if the principal of a cannabis company gives you a basis to reasonably rely on the person and company not really being separate by telling you he or she will personally cover your debt if the company runs into trouble and cannot pay you. The same would be true if the principal disregards corporate separateness by commingling his or her assets with those of the company and the company runs into trouble because it cannot pay you.
These principles first emerged in the 19th century in England’s Chancery Court, which could provide remedies the courts of law could not such as injunctive relief (ordering someone to do or not do something), or specific performance (ordering someone to perform his or her side of a contract). Whereas courts of law were hemmed in by the common law system of following precedent (known as stare decisis), the Chancery Court could explicitly consider factors like fundamental fairness.
When the court decides if the circumstances of the case warrant some degree of veil piercing, there are some well known factors the court will consider. These are often as misunderstood as they are invoked: undercapitalization and failure to observe corporate formalities. While the terms themselves hardly need definition, the application of these factors to the veil piercing analysis can be something of a hot mess. While it is true many instances of successful veil piercing involve undercapitalization or disregard for corporate formalities, neither is sufficient on its own to trigger the remedy. Instead, the undercapitalization or inadequate corporate separateness needs to be causally related to some kind of cognizable fraud or injustice suffered by the proponent of piercing.
In sum, while the idea of holding individual owners personally liable for a cannabis company’s debts is understandably attractive to creditors left empty-handed, the threshold for piercing the corporate veil remains intentionally high. Courts are reluctant to disturb the foundational principles of corporate law unless there is clear, compelling evidence that the owners misused the corporate form to perpetrate a fraud or injustice. For better or worse, frustration with nonpayment simply is not enough.