Piercing the Veil

The doctrine of piercing the veil allows courts to disregard the legal fiction that a corporation or trust is a separate entity from its owners or beneficiaries so that the owners or beneficiaries can be held personally liable for the debts or obligations of the corporation or trust.

While the doctrine is most commonly used in the context of corporate law, where courts will allow creditors of a business entity to hold the entity’s shareholders or members personally liable by disregarding the corporate entity's separate legal status, in the context of trusts, piercing the veil involves a similar concept whereby courts may set aside the protection of a trust to hold and allow a settlor’s or beneficiary’s creditors to satisfy their claims against the trust’s assets. 

The similarity of treatment between corporations and trusts makes sense when you consider that both are legal entities meant to be separate from their owners/shareholders in the case of corporations, LLCs, and LLPs, and their beneficiaries in the case of trusts. 

Factors Courts Consider When Piercing the Veil 

Some of the specific factors courts will use to determine whether to pierce the veil of a trust include:

• Undercapitalization: A court may pierce the veil if the trust has insufficient funds or assets to meet its obligations. For example, if a trust created for a business venture lacks the necessary funds to cover potential liabilities, courts might pierce the veil for the benefit of creditors.
• Comingling of assets: This refers to when one mixes trust assets with personal ones. For example, if one uses their trust’s funds to cover personal expenses, the distinction between trust and personal assets may be compromised, and the courts might disregard it as a separate identity.
• Fraud or misrepresentation: When a trust is established based on false information or manipulated circumstances, courts may pierce the veil to address fraudulent behavior and protect creditors from being misled. For example, if a settlor creates a trust and misrepresents their assets to creditors, the court may pierce the veil and hold the settlor personally liable for the trust's debts.
• Excessive control: If one exerts excessive control over the management of the trust’s assets or the disbursement of its funds, a court might find that they are treating them as personal property, and hence determine that piercing the veil is appropriate. 

Example: Michael establishes a self-settled trust to shield his assets from creditors. However, instead of leaving decisions regarding the operation of the trust and how its funds would be distributed to the trustee’s discretion, he consistently involved himself in how the funds were being invested. Furthermore, he regularly withdrew funds from the trust to pay for vacations and other luxury purchases. Eventually, John racked up a lot of debt, and his creditors sued him. Having no other assets other than the trust, the creditors petitioned the court that it pierce the veil so that they could satisfy their claims against the trust’s assets. After reviewing the evidence, the court determined that due to John’s excessive control over the trust, and since he treated its funds as his own, piercing the veil was warranted and allowed the creditors to assert their claims against the trust property.