The Limits of Limited Liability: When Courts Pierce the LLC Veil

Photo by Kevin Matos on Unsplash

Introduction

Behind every corporation or LLC lies a fundamental policy tradeoff: encourage economic risk-taking through limited liability, but prevent owners from using that protection to commit wrongdoing. When that balance breaks down, courts invoke the doctrine of piercing the veil, disregarding the entity form and imposing personal liability on its members. As LLCs have overtaken corporations as the dominant choice for new businesses, the doctrine has begun to evolve, and the differences between states like California and Delaware are shaping how far limited liability truly extends. 

Limited liability is a cornerstone of business law, but it has limits. Courts step in when the entity is misused, applying the doctrine of piercing the veil

What is Piercing the Veil

At its core, piercing the veil allows courts to disregard the separation between a business entity and the individuals behind it when that separation is being used as a shield of misconduct. As the California Court of Appeal put it, “when a plaintiff comes into court claiming that an opposing party is using the corporate form unjustly and in derogation of the plaintiff's interests, [i]n certain circumstances the court will disregard the corporate entity and will hold the individual shareholders liable for the actions of the corporation[.]’ ” Limited liability is meant to encourage entrepreneurship by reducing personal risk, not to give owners a free pass to engage in fraud, evade creditors, or manipulate the entity for personal gain.

A corporation is a separate legal entity with the power to sue and be sued, own property, and enter into contracts in its own name. Because of this, corporations generally limit liability for the owners, as no shareholders are personally liable for corporate debts. 

Most jurisdictions follow a test requiring the proponent to demonstrate two elements:

1. a unity of interest and ownership such that the separate personalities of the corporation and the individual do not exist; and

2. an inequitable result if the corporate identity is not disregarded

   
   

Courts have described unity of interest and ownership as circumstances where the business and its owners lack true separateness. This factual determination may include commingling of assets or accounts, inadequate capitalization, identical ownership or control, use of the entity as a mere shell or conduit, failure to maintain records or observe whatever formalities do apply, and use of entity funds for personal expenses. Even if unity of interest is shown, courts also require a demonstration that allowing the entity to stand would sanction fraud or promote injustice. As the Delaware Court of Chancery has explained, the plaintiff must show an “overall element of unfairness,” not merely the existence of an unpaid debt.

Shift from Corporations to LLCs

LLCs have quickly become the preferred business form because they offer pass-through taxation, flexible governance, and contract-driven structures with fewer mandatory formalities than corporations. This shift matters for veil-piercing because many of the traditional factors, such as failure to hold meetings or keep minutes, simply do not apply to LLCs unless chosen by the members themselves. California makes this explicit: “the failure to hold meetings… or observe formalities… shall not be considered a factor” in determining alter ego liability unless the operating agreement requires them. As a result, LLC veil-piercing focuses less on formalities and more on misuse of the entity, inequitable conduct, and abuse of the LLC structure.

Piercing the Veil in LLCs: California Approach

California explicitly extends veil-piercing to LLCs (Cal. Corp. Code § 17703.04(b)) but emphasizes just how rarely the doctrine should apply. Courts consistently describe alter ego as an “extreme remedy, sparingly used,” with the plaintiff bearing a heavy burden to show both unity of interest and an inequitable result. Determining alter ego is a fact-intensive inquiry reserved for the trial court, and California courts have reaffirmed the difficulty of meeting the standard in recent cases. 

California also limits what counts as evidence of alter ego in an LLC. Because LLCs eliminate most formalities, courts do not consider the absence of meetings or minutes unless the operating agreement requires them. Instead, California courts look for misuse of assets, manipulation of the entity, and conduct that would lead to inequity if the veil were not pierced.

Piercing the Veil in LLCs: Delaware’s Approach

Delaware, the nation’s leading business jurisdiction, takes an even more protective approach. Delaware courts repeatedly emphasize that veil-piercing is “a tough thing to plead and a tougher thing to get,” applied only in the “exceptional case.” While Delaware considers whether the LLC was adequately capitalized, solvent, or used as a façade, no single factor controls; the touchstone is whether the entity was abused as a sham for no purpose other than fraud.

Because LLCs in Delaware are “creatures of contract,” courts give significant weight to the operating agreement and to the members’ intentional choice to limit liability. This strong respect for entity separateness makes Delaware one of the most difficult jurisdictions in which to pierce the LLC veil.

Changing Orders

A key reason LLC veil-piercing is so rare is the availability of charging orders, a statutory remedy that protects both the LLC and its non-debtor members. A charging order grants a creditor only the right to receive distributions that would have gone to the debtor-member. In California and Delaware, the creditor cannot seize LLC assets, demand liquidation, or assume management rights.

Charging orders reflect the intent behind LLC statutes: to preserve the entity’s operational integrity while giving creditors a narrow, controlled remedy. Because charging orders already restrict creditors from invading the LLC itself, courts are even more reluctant to pierce the veil unless there is clear evidence of alter ego abuse.

Policy & Market Effects

As LLCs continue to dominate business formations, courts face the challenge of applying a doctrine created for corporations to a far more flexible entity type.

Courts now place far less emphasis on formalities, which LLC statutes intentionally minimize, and instead focus on misuse of the entity and equitable concerns. Single-member LLCs attract greater scrutiny because the lack of multiple owners increases the risk of using the entity as a personal extension. At the same time, creditors face significant barriers, as charging orders limit their remedies and veil-piercing remains rare.

These dynamics influence where founders choose to form their businesses: Delaware offers unmatched entity protection, while California provides flexibility but is more willing to scrutinize inequitable conduct.

Moving Forward/Implications

Courts and lawmakers will likely refine LLC veil-piercing rules slowly and carefully. The goal is clearer guidance for everyone without weakening the strong limited liability that encourages people to start businesses and take risks. Future reforms could introduce clearer standards, such as objective tests for adequate initial capitalization, mandatory disclosures in high-risk scenarios, or statutory safe harbors that protect members who adopt and follow robust, well-drafted operating agreements. These steps could help creditors predict outcomes while keeping LLCs flexible. However, making veil-piercing too easy could scare off founders. They might avoid bold moves, demand personal guarantees, or underfund projects to play it safe, slowing innovation.

Change will likely unfold in small measured steps rather than bold overhauls. Delaware will hold its position as the safest harbor for ironclad limited-liability protection and continue to pull in most founders who value certainty above all. California and similar states may give creditors slightly more leeway when misconduct is clear, allowing courts to closely examine facts that amount to actual fraud. Piercing will still be the exception, not the rule. Single-member LLCs will stay under a sharper microscope simply because the owner-company divide looks thinner. 

At its core the doctrine remains a remedy of last resort for blatant abuse. Founders who draft tight operating agreements, keep clean books, never dip into company funds for personal use and document everything at arm’s length will sleep easy and keep the flexibility LLCs promise. In the years ahead courts and legislatures will keep searching for the right line that offers real recourse for creditors without blunting the risk-taking spirit that drives new businesses forward.

Conclusion

Piercing the veil remains one of the most powerful and least frequently applied doctrines in business law. As LLCs have eclipsed corporations as the dominant business form, courts have adapted the doctrine to reflect LLCs’ contractual nature, reduced formalities, and strong statutory protections such as charging orders. California and Delaware share the same fundamental principles but diverge meaningfully in their strictness and deference to entity separateness. The message for founders and investors is clear: the LLC form offers substantial protection, but not unconditional immunity.

*The views expressed in this article do not represent the views of Santa Clara University.