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