Lifting the Veil on Owner Liability
The Ins and Outs of Piercing the Corporate Veil
I am sure many of you have heard the term Piercing the Corporate Veil before, but do you really know what it means. What the term refers to is when a corporation or limited liability company creditor attempts to enforce company debts against the owners of the company. This article will outline what the theory is and some ways you can protect yourself from having someone pierce your company’s veil of protection.
One of the biggest advantages to incorporating or organizing a business is that the owners of the corporation or company enjoy broad protection from being held personally responsible for the debts and liabilities of the corporation. Generally, creditors can reach the corporation’s assets, but once those assets are exhausted the creditor cannot ordinarily also reach the personal assets of the owners, shareholders or members of the corporation or company.
However, under some circumstances, company creditors attempt to pierce the corporate veil. This ordinarily happens in civil litigation, where the corporation is believed to have inadequate assets to cover its liabilities, and the plaintiff alleges that the corporation is actually a sham – that is, the corporation is not really a distinct individual, but is merely an extension or “alter ego” of its owners which is being used to advance their private interests or to perpetrate a fraud.
As the precise facts and circumstances which can result in a piercing of the corporate veil will vary, it is important to consult with a qualified attorney when evaluating whether the corporate veil may be pierced in any specific case.
Factors Considered by Courts
Generally, when evaluating if a corporation is in fact legitimate, or if the corporate veil should be pierced, courts look at the following factors:
- Corporate Formalities – Did the corporation follow proper procedure, for example in its formation and appointment of directors, issuance of stock, the holding of its annual meetings, the filing of annual reports with the state, and the maintenance of its own property, and financial books and accounts?
- Proper Funding – Was the corporation started with sufficient capitol to run the business or was the company dependent on property or assets of a shareholder which it did not technically own or control?
- Personal Use – Did the principals use the corporation to advance personal purposes?
- Commingling of Funds – The single most important factor that courts look at is whether the company funds and personal funds of the owners were commingled, or used interchangeably. The court will look at whether the owners paid personal bills from company money and whether a separate account and books were kept for the company.
If the court examines those factors and concludes that there is such unity of interest between the corporation and its shareholders that they are inseparable, and it would be unjust to permit the corporate form to stand, a court will typically pierce the corporate veil.
A court may also pierce the corporate veil to prevent a fraud, where the corporation is found to be a “sham” meant to facilitate fraud against third parties. If the corporation was set up, for example, to shield its owners from liability over a fraudulent real estate transaction, and the owners siphon out the corporate assets such that the corporation is unable to compensate the victims of the fraud, a court is likely to set aside the corporation and allow the victims to recover from the personal assets of the owners.
How to Protect Your Business
Therefore, some simple keys to protect yourself from having the corporate veil pierced is to properly form and manage your company. Be sure that when your new company is formed you follow through with all of the necessary paperwork. If for any reason you are not sure what paperwork is required be sure to consult with competent legal counsel. There is no point in quickly forming a company without the advice of counsel when this can defeat your entire purpose for forming the entity.
Also, be sure not to commingle your accounts. Open a separate a bank account for your business and keep all business and personal funds separate. Also be sure not to pay personal bills out of company funds. Pay yourself, then pay your bills. By following these simple steps you can be sure to keep the liability you were looking for when starting your business.