The Corporation as a Nexus for Regulation

Mariana Pargendler is Professor of Law at Fundação Getulio Vargas School of Law in São Paulo and Global Professor of Law at New York University School of Law. This post is based on her recent paper, forthcoming in the University of Pennsylvania Law Review.

As a legal person or entity, a corporation is the repository of rights and duties in its own name. It is legally separate from its shareholders and managers. Current legal and economic scholarship views asset partitioning—the separation between the assets of the corporation and those of its shareholders—as the essential economic role performed by legal personality. The law also recognizes exceptions to asset partitioning and provides for “departitioning remedies,” of which veil piercing is the most prominent. Through veil piercing, courts overcome the attribute of limited liability to hold shareholders liable for corporate debts in certain circumstances.

This view, however, is incomplete, as I show in a paper entitled Veil Peeking: The Corporation as a Nexus for Regulation, which is forthcoming in the University of Pennsylvania Law Review. First, I identify the provision of regulatory partitioning (the separation between the regulatory spheres of the corporation and its shareholders) as another fundamental function of the corporate form. Second, I show that regulatory partitioning is not absolute. In various areas of law and for different purposes, the law “peeks”—or looks behind the corporate veil—to ascribe legal rights or detriments of shareholders to the corporation.

To illustrate, consider the following stylized example: Alice, a prominent entrepreneur who also holds a small number of shares in Apple Inc., a publicly-traded company. As we would expect, regulatory partitioning means that Apple is not bound by the non-compete covenants that Alice has signed in connection with her business. If Alice is convicted of a crime and is therefore barred from contracting with the federal government, Apple is not affected by this sanction. Alice is a French citizen, while Apple is a U.S. company incorporated in California. This form of separation between the legal spheres of Alice and Apple is essential to the operation of large-scale enterprise with multiple shareholders and transferable shares. However, if Alice were a controlling shareholder of Apple, lawmakers and courts would sometimes extend Alice’s non-compete obligations and debarment sanctions to Apple, as well as deem Apple to be French.

The paper identifies the role of regulatory partitioning as an essential, but thus far overlooked, form of legal separation supplied by the corporate form. The reconceptualization of the corporation as a “nexus for regulation” beyond its well-known role as a “nexus for contracts” offers a critical, and heretofore overlooked, rationale for the organization of economic activity under the corporate form in the United States and around the world. Importantly, however, regulatory partitioning is not absolute. In various fields and for different purposes, the law engages in what I term veil peeking by looking at shareholder characteristics to impute certain rights or qualities of shareholders to the corporation, without, however, compromising the attribute of limited liability to reach the personal assets of shareholders.

The tension between regulatory partitioning and veil peeking lies at the heart of key contemporary and perennial controversies involving the corporate form. The issues are both varied and highly consequential. Should the fundamental rights of individuals (such as free speech and religious liberty) apply to corporations as a vehicle for their exercise? Do a parent and a wholly-owned subsidiary count as separate entities for purposes of a conspiracy under antitrust law? Can a subsidiary be sued based on jurisdictional grounds applicable to its parent? Can the race of individual shareholders be imputed to the corporation for purposes of antidiscrimination laws? Does the nationality of corporate shareholders matter for the application of international investment treaties or wartime restrictions? Can citizens raise constitutional rights against a corporation whose shares are owned by the government? When is it lawful to adopt the corporate form to circumvent legal constraints applicable to individuals or other legal entities, ranging from homestead exemptions to non-compete covenants?

In response to these questions, lawmakers and courts have sometimes decided to “peek”—or look behind the corporate veil—to ascribe legal rights or detriments of shareholders to the corporation, thereby mitigating regulatory partitioning. Although veil peeking is deep-rooted and recurrent, it has largely escaped dedicated analysis. From the first article on veil piercing in the early twentieth century to countless judicial decisions and pieces of scholarship (old and new), what I call veil peeking has been improperly equated with, or subsumed under, veil piercing doctrine, which generally operates to hold shareholders liable for corporate obligations.

The paper examines the phenomenon of veil peeking from a legal and economic perspective and distinguishes it from veil piercing as an exception to limited liability. Veil piercing tempers asset partitioning by imposing shareholder liability for contracts, torts or regulatory claims. Veil peeking mitigates regulatory partitioning by enabling the imputation of shareholder rights or detriments to the corporation. Because asset partitioning and regulatory partitioning serve different economic functions, veil piercing (as asset departitioning) and veil peeking (as regulatory departitioning) entail distinct tradeoffs and should be subject to different criteria.

Unlike veil piercing, which is inevitably anti-shareholder and pro-regulation, veil peeking has no clear ideological connotation: it can be used both to augment and to frustrate the privileges of shareholders and the regulatory power of the state. Moreover, asset partitioning and regulatory partitioning are not necessarily subject to the same boundaries, nor is regulatory partitioning subject to uniform boundaries across legal issues or areas of law. Exceptions to regulatory partitioning through veil peeking are pervasive across history and legal fields, which makes corporate separateness an “on-and-off” construct depending on the purpose of any given form of regulation.

The complete paper is available for download here.

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