How Can a Person That Owns a Corporation Get Sued for Fraud?

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One of the biggest advantages of a corporation is that this business structure protects controlling shareholders from personal liability for the debts and liabilities of the business. This protection does not mean that persons involved with the corporation can undertake fraudulent activities and enjoy immunity under corporate liability protection. Officers, directors and controlling shareholders of the corporation owe the other shareholders a fiduciary duty. Under the legal theory of “piercing the veil,” a controlling shareholder can be held personally responsible for fraudulent actions by the corporation initiated by that individual.

Corporation Basics

A corporation is a legal entity that is registered with the state. Ownership in the corporation is denominated by shares. The more shares an individual owns, the greater his influence on the company. A key feature of the corporation is its liability shield. In general, the corporation is considered a separate legal entity. This means that the actions of the corporation are considered separate from the owners of the corporation. As a result, the owners and officers of the business usually are not held personally liable for the actions or debts of the corporation.

Fraud Defined

The legal definition of fraud is a knowing, intentional misrepresentation of a material fact that is meant to induce another to take an action. For the misrepresentation to be actionable as fraud, the other party must rely on the fraudulent statements to his own detriment. Fraud is not limited to statements. If a corporate principal intentionally withholds information that makes other statements misleading, that also constitutes fraud. A material fact is one that a party relied on to make a decision. Unfulfilled promises do not constitute fraud unless the promise was made by someone who had no intention of following through.

Fiduciary Duty

A controlling shareholder of a corporation has a higher fiduciary responsibility. As a fiduciary, the owner-shareholder owes a duty of loyalty and care to the other shareholders. For that reason, the individual is required to take actions that benefit all shareholders, and he cannot enrich himself to the detriment of the others. Controlling shareholders are also required to exercise basic competence when acting on behalf of the corporation.

Piercing the Veil

The term “piercing the corporate veil” refers to a legal concept in which a controlling shareholder can be held legally liable for the actions of the corporation he owns. A corporation’s legal status acts as a veil between corporate acts and personal responsibility. If a controlling shareholder breaches his fiduciary duty through gross negligence or acts in bad faith, he may be held liable for those acts, which “pierce” the corporate veil. Fraud constitutes an act of bad faith. Another way the veil may be pierced is if the corporate structure was used to perpetuate a fraud on the public. An example of such a fraud would be if a corporation was created with few contributed assets by the shareholder, and then the corporation is used to incur debts far exceeding the corporate resources with no intention of repaying the liabilities.