Building a business is hard, yet fulfilling, work. Whether you own a limited liability company (LLC) or a corporation, your business protects your personal assets by separating them from your business’ liabilities, debts, and obligations. This “corporate veil” shields your personal bank accounts, possessions, car, and even your house, from legal seizure in the event of a lawsuit.
Like all things, this corporate veil shield is not a perfect defense. If you, as a business owner, don’t take steps to treat your business as a separate, distinct, legal entity, potential creditors could ask courts to “piece the corporate veil,” and directly seize your personal assets to satisfy your business’ debts and financial obligations.
Let’s look at some ways your “corporate veil” can be pieced, and what you can do to protect your personal assets from unwanted exposure and seizure.
How Courts Pierce the Corporate Veil
The easiest justification a court can have to pierce a company’s corporate veil is if it has cause to find an “alter ego,” that is, evidence that the business is not truly an independent entity, but rather an extension of its owner’s personal activities and finances. For example, while a business owner may have validly registered his LLC in his state, the LLC may be an alter ego if the owner commingles the LLC’s revenues with his own personal bank account funds. This would give a court justification to piece the LLC’s corporate veil, and seize the owners personal assets.
A number of tell-tale signs allow courts to pierce the corporate veil–all of which speak to the business owner’s inability to preserve their business (LLC or corporation) as a completely separate legal entity. These include:
- Commingling of Funds: the business does not have a dedicated business checking account used for all its income and expenses. Instead, business owners place company revenue in their own personal bank accounts, and withdraw from the same to pay off business expenses.
- Failure to Keep Business Assets Separate: Business assets, such as property, equipment, and resources, are not exclusively held in the business’ name. Instead, the owner treats these assets like personal property.
- Practicing Poor Corporate Hygiene: A corporation’s veil can be pierced if business owners fail to document all business-related decisions, votes, and stock issuances. This includes failing to keep updated stock and financial ledgers, membership documentation, meeting minutes, voting records, and filing annual reports and paying business fees. Good corporate hygiene also entails creating defined corporate policies and procedures to ensure fairness, transparency, and legitimate decisionmaking while operating the business.
- Inadequate Capitalization: If a business is not sufficiently funded, courts will question whether the entity was formed for a legitimate business venture, or merely to act as a shell company for the owner’s personal financial gain. Failure to provide reasonable capitalization for the specific purpose of your business could increase the likelihood of veil piercing.
- Identity Confusion: If a business owner signs deals or agreements in their own name, it will be difficult to show a court of law how the business’ interests are completely separate from the owner’s.
While these are surefire ways to make it more likely for a court to pierce your business’ corporate veil and expose your personal assets to seizure or liquidation, ensuring these corporate governance principals and corporate hygiene steps are followed will help in separating your personal assets and funds from the business’.
LLCs vs Corporations-The Importance of Corporate Records
While the legal doctrine of piercing the corporate veil applies to both corporations and LLCs, courts view these two business entities slightly differently for the purpose of veil piercing.
LLCs are the more flexible business entity, often formed to be run more informally and with greater flexibility compared to the rigidity of traditional corporate formalities and procedures. That being said, LLCs must still practice good corporate hygiene and respect governance principles to prevent a veil piercing scenario. While LLCs are held to a lower standard in terms of recordkeeping, it is still important for LLC members to document key actions, votes, resolutions, etc.–this is often performed through the LLC’s Operating Agreement and member resolutions. Likewise, an LLC must maintain separate financial accounts and document major business decisions and transactions to defend against the alter ego theory.
Since corporations are regulated by state statutory law, they are held to a higher standard than LLCs, and are therefore more susceptible to veil piercing. Since corporations are more strictly regulated, shareholders must hold regular shareholder and director meetings, issue stock, adopt and follow its bylaws, and keep all original financial records on hand– while documenting each action, meeting, and event in its corporate books and ledgers.
While LLCs and corporations are viewed differently for legal purposes, the message remains the same: follow good corporate governance principles, don’t commingle assets, and keep accurate and dependable business records to show how your business is being managed in good faith, transparency, and for legitimate professional purposes separate from your own personal financial gain.
Best Practices
Piercing the Corporate Veil is often seen as the “last resort” courts will take to provide a party with equitable relief. There is a strong presumption against veil piercing, and simply missing formalities may not be sufficient to pierce the veil and attach a business owner’s personal assets, unless there is also evidence of fraud or improper conduct. However, it is important to consistently maintain these good corporate governance principles. As a business owner, you should keep up-to-date corporate records, hold separate bank accounts for your business and personal finances, adequately capitalize your business, stay up-to-date on annual filings and fees, and keep managing your business with transparency and in good faith.
Ensuring your business remains in good standing both financially and legally is a constant endeavor. Reach out to one of our experienced corporate attorneys if you have any questions regarding corporate hygiene, strategies to defend against corporate veil piercing, or any other questions regarding your business.
