Academic journal article Stanford Journal of Law, Business & Finance

Contract-Centered Veil Piercing

Academic journal article Stanford Journal of Law, Business & Finance

Contract-Centered Veil Piercing

Article excerpt

The application of the doctrine of piercing the corporate veil to contract disputes has been attacked as undesirable. This article shows that applying piercing to contracts is desirable. Contract-centered veil-piercing functions akin to a penalty-default clause that encourages the efficient production of information, avoids wasteful precaution, and promotes the use of the corporate form for entrepreneurship.

Introduction

A private helicopter takes off. Two men in dark suits are its only passengers. One is a U.S. senator, the other his trusted assistant. They talk amiably as the senator enjoys the view of the tranquil, sun-drenched Potomac under them. Suddenly, the assistant is transformed into a blue-feathered woman, an evil mutant who proceeds to attack and kidnap the senator. This scene from the X-Men feature film1 (see figure 1) illustrates the importance of errors about identity. Had the senator known the true identity of his companion, he would have avoided the risk of an insecure meeting.

Subsidiaries can expose outsiders,2 with whom they enter into contracts, to errors similar to that of the senator. The senator inferred that his assistant's incentives not to attack him were sufficient but those incentives did not apply to the actual passenger because of the senator's error about the passenger's identity. Likewise, outsiders think that subsidiaries' incentives are sufficient to perform their contracts. Yet, those incentives may not apply because the subsidiaries (a) may be subjugated,3 having become puppets in the hands of dominating puppeteers, who have no regard for their interests, or (b) have no assets, and nothing to lose from breaching, whereas the outsiders thought they were contracting with their apparently solvent parents.

The doctrine of veil piercing (also shortened here to "piercing") extends the outsider's claim so that it encompasses the controller, the puppeteer, or the asset-rich parent.4 Piercing overcomes errors about independence and size or solvency; piercing, thus, restores the incentives of contract law. But for piercing, outsiders would have little protection.5 Contrary to recent claims,6 piercing in contract disputes is desirable.7

Part II demonstrates the schism in legal attitudes about piercing by contrasting the academy's preference for piercing in tort rather than contract, with the courts' preference for piercing in contract rather then tort. Part II searches for the function of contract-centered piercing by asking how outsiders would react to its absence. Part III shows that the primary function of piercing is that of a penalty default clause.8 The parent avoids the threat of future piercing by informing outsiders about the subsidiary's assets and control structure. Part IV concludes.

I. The Schism about Piercing

The jurisprudential attitudes about veil piercing are in tension. The academy's attitudes toward veil piercing are strongly in favor of piercing in tort but not in contract. In contrast, the courts disfavor piercing in tort and favor piercing in contract.

A. The Academy's Bias for Piercing in Tort

The source of the academy's biases about piercing may be confidence in the role of deterrence. Tort law might receive explanations besides deterrence, such as compensation and, more rarely, retribution.9 Yet, those uniquely fail to justify tort law. Compensation can come from insurance and retribution from criminal or administrative sanctions.10 Unique nuance dresses tort law if it is viewed as an incentive for balancing care and risk.11 Some very high levels of care become unjustified because the accidents they prevent are exceedingly unlikely and small. Tort liability, therefore, is an incentive. It leads to the desirable balancing of risk and care.

Against this understanding of tort law, the academic view of the importance of the protection of contract law is small.12 Contracting parties are governed by freedom of contract and the principle of "buyer beware. …

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