Incorporating for Fraudulent or Illegal Purposes
Contact Neufeld Legal PC for your incorporation legal work at 403-400-4092 / 905-616-8864 or Chris@NeufeldLegal.com
Incorporating a company with a fraudulent or illegal purpose is a serious legal violation that can have major consequences, primarily by leading a court to "pierce the corporate veil." Normally, one of the main benefits of a corporation is limited liability, which protects the personal assets of the shareholders, directors, and officers from the company's debts and liabilities. However, when a corporation is used for an illegal or fraudulent scheme, courts can take away this protection.
The most significant consequence of a court determination that the company had been incorporated for a fraudulent or illegal purpose would see the court pierce the corporate veil, which means:
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Personal Liability: The court will disregard the legal separation between the corporation and the individuals who control it (shareholders, directors, or officers). This holds those individuals personally liable for the company's debts and liabilities.
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Loss of Asset Protection: Their personal assets (like homes, savings, and investments) are no longer shielded and can be used to satisfy legal judgments, penalties, and debts resulting from the fraudulent or illegal activity.
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Punitive Damages: Individuals found to have engaged in egregious fraudulent or deceitful behavior may also be held personally liable for punitive damages.
While the specifics can vary by jurisdiction, courts generally look for two main conditions to justify piercing the corporate veil in cases involving fraud:
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Domination and Control: The corporation is completely dominated and controlled by one or a few individuals, making it a "mere puppet" or "alter ego."
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Improper Purpose: The individual(s) used this control to make the corporation a shield for fraudulent, illegal, or improper conduct or to avoid an existing personal obligation.
Beyond the loss of limited liability, individuals involved in incorporating or running a business for fraudulent or illegal purposes can face:
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Criminal Charges: Individuals can face criminal prosecution for offenses like fraud, conspiracy, money laundering, and other criminal activities, leading to imprisonment and substantial criminal fines.
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Regulatory Penalties: Enforcement actions, fines, and sanctions from government bodies (like tax authorities, securities commissions, etc.).
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Civil Lawsuits: The corporation and its controllers will be sued by victims of the fraud (e.g., investors, creditors, customers) to recover damages.
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Injunctions and Dissolution: The court may issue orders to stop the illegal activity, or the federal or provincial government may move to dissolve or cancel the corporation's articles of incorporation.
The incorporation of a company for fraudulent or illegal purposes typically revolves around schemes to leverage the separate legal entity status and anonymity that corporations afford, as exemplified by:
A. Money Laundering Schemes
Corporations, particularly shell companies (those with no significant assets or operations), are a key tool in the layering stage of money laundering, where they are used to obscure the illegal source of funds.
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Cash-Intensive Businesses: Criminals incorporate businesses like laundromats, restaurants, car washes, or strip clubs and then "mix" illegal cash with legitimate revenue by over-reporting daily cash sales. The illegitimate money is then deposited into the banking system, appearing as clean business profit.
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Shell Companies for Fake Transactions: A shell company can be used to issue fraudulent invoices for services or goods that were never rendered. Illicit funds are then transferred to the shell company to "pay" these invoices, creating a false paper trail to justify the movement of the money.
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Real Estate Transactions: Criminals use shell companies to purchase real estate with illegal funds. The property is later sold, or rented, converting the "dirty" money into "clean" assets with a seemingly legitimate origin.
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Trade-Based Money Laundering (TBML): Corporations are used to create fake import/export transactions or to intentionally over- or under-value goods and services in international trade to move illicit funds across borders.
B. Tax Evasion and Tax Fraud Schemes
Incorporating can be used to illegally avoid paying taxes, which is different from legal tax avoidance.
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Offshore Tax Evasion: Creating a shell or offshore company in a tax haven to illegally hide income, assets, or ownership. The corporation is used to channel profits to a jurisdiction with minimal or zero tax, making it difficult for the home country's tax authorities to trace and collect taxes.
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Skimming and Concealing Income: A business owner may operate a corporation and deliberately under-report gross receipts (skimming) or keep two sets of books to conceal the true amount of income earned, thereby evading taxes.
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Claiming Personal Expenses as Business Expenses: Using corporate funds to pay for significant personal expenses (like a home, car, or luxury items) and then falsely claiming them as deductible business expenses on the company's tax return.
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Sham Transactions: Incorporating an entity to engage in a transaction that lacks economic substance, but is solely designed to generate an illegal tax deduction or to disguise the true nature of a payment.
C. Financial Fraud and Deception
Corporations can be created as a vehicle for outright fraud against investors, creditors, or the public.
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"Pump and Dump" Schemes: Creating an empty dummy corporation with a name similar to a legitimate, well-known company. Fraudsters then mislead investors into buying worthless securities in the dummy company, inflating its price ("pump"), before selling their own shares for a massive profit ("dump").
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Hiding Stolen Funds: A corrupt individual may incorporate a private shell company to act as a funnel to divert and conceal stolen public funds, bribes, or misappropriated assets.
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Fraudulent Contracts/Liability Evasion: A person might incorporate a new company just before engaging in a risky or wrongful transaction to shield their personal assets from liability. When the transaction goes sour, the corporate entity is left holding the debt, and the principal simply abandons the empty company (sometimes referred to as "piercing the corporate veil" situations).
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Identity Concealment: Incorporating an entity to conceal the identity of a criminal or a person's true beneficial ownership of assets, which can be used to facilitate various other crimes.
If your business is seeking experienced professional legal representation with respect to incorporating a new corporation or dealing with the corporate legalities impacting your company, contact us at 403-400-4092 [Alberta], 905-616-8864 [Ontario] or via email at Chris@NeufeldLegal.com.
