One of the primary reasons that business owners form a corporation or an LLC for their business is to protect themselves from potential personal liability. While this can be a successful strategy, if a business owner ignores the separateness of the corporation or LLC in order to perpetrate fraud or avoid responsibility, or if the entity is undercapitalized (when the company does not have enough capital to support the ordinary business debts) in an attempt to avoid future debts, courts may pierce the “corporate veil” and come after the individual business owners.
The idea of piercing the “corporate veil” is generally applied to remedy injustices that arise when a party has abused the corporate form in order to defeat justice, perpetrate fraud, or to evade contractual or tort responsibility. Courts pierce the corporate veil under this theory when the business is a mere vehicle for the owner to transact his own affairs so that there is such unity of interest and ownership that the separate personalities of the business and its owners no longer exist. Courts also pierce the corporate veil based on undercapitalization. For undercapitalization to pierce the corporate veil, however, there must also be evidence of an intent at the time of the capitalization to improperly avoid future debts of the entity.
There is no exact formula that determines when a court will pierce a company’s corporate veil and hold an individual business owner liable for the company’s debts because the applicability of this doctrine depends on the facts and circumstances of each case. However, complying with the following may help protect individual business owners from the company’s liabilities.
• Ensure that all letterhead, stationary, invoices, and other documents state the company’s name.
• Hold company out to the public/ third parties as a separate and distinct entity from the individual business owners.
• Open and maintain a separate bank account for the company.
• Do not commingle or confuse any of the company’s assets with the business owners’ personal assets.
• Adequately capitalize the company enough to carry the normal strains and debts upon it. It is important that the company is and remains solvent. (Solvency is when the company’s assets exceed its liabilities).
• Sign all business documents in a representative capacity on behalf of the company.
• Title all business assets in the company’s name.
• Observe all corporate formalities of the company and keep written records of compliance with those formalities. For examples, do not commingle or confuse the company’s records with your personal records, file annual registrations with the Secretary of State, obtain an Employer Identification Number (EIN) for the company, pay all taxes and license fees for the company (e.g., payroll taxes, business license, county tax), have owner meetings and document those meetings in minutes.
• Maintain the company’s office at a location/address separate from your home.
While the above factors may help prevent a court from piercing the “corporate veil” of a company and holding the individual business owners liable, it is important to remember that there is no exact formula that determines with precision when the court will pierce a company’s corporate veil and hold its owners liable for the debts of the company.
This article is not intended to establish an attorney-client relationship and is not intended to confer legal advice. No attorney-client relationship should be inferred in the absence of a written and executed engagement agreement that expressly indicates the creation of an attorney-client relationship.
Written by: Heather Wagner