Business owners can take advantage of various corporate structures that protect them from personal liabilities when owning a business. However, a term referred to as “piercing the corporate veil” can restrict this protection. An experienced business lawyer with Sunridge Legal can explain this complex topic and devise ways to protect your legal and financial rights, as well as those of your company. Learn more about all of your legal options by contacting our legal team for a confidential appointment today at [email protected].
Business Structures
There are many different types of business structures that a company can choose from, some of which protect owners from personal liability and some which do not. Sole proprietorships and partnerships generally do not protect owners from personal liability. Owners report business income on their personal tax return and are taxed at the individual rate.
According to the Small Business Administration, limited liability companies (LLC) protects owners from personal liability in most instances. The Small Business Administration reports that corporations offer the strongest protection to businesses. The corporation is considered a separate entity from the individual owners.
What Is the Corporate Veil?
The corporate veil is an imaginary shield that divides a business from its owners for the purposes of liability. Corporations, limited liability companies, and other types of business structures shield business owners from such things as:
- Liability from debts
- Legal claims for mismanagement of the business, personal injury, or other liabilities
- Negligence
What Is Piercing the Corporate Veil?
Piercing the corporate veil means that a court removes limited liability from the shareholders, officers, or directors so that they are made personally liable for the corporation’s actions or debts. This happens when a court finds that the corporate structure is merely a fiction that the company uses to achieve an inequitable result.
When Courts Might Pierce the Corporate Veil
Courts generally have a strong presumption against piercing the corporate veil and will respect the business structure the owners have proactively put in place. While courts have the equitable authority to pierce the corporate veil, they only do so “reluctantly” and “cautiously,” according to the Harvard Law School Forum on Corporate Governance. However, there may be times when the court may decide to pierce the corporate veil, such as when the business or its representatives:
- Failed to keep the business and person separate
- Under capitalize the corporation so that it could not stand independently
- Fail to adequately maintain capital in the business
- Failed to maintain separate structures for affiliates or subsidiary companies
- Committed fraud, wrongdoing, or injustice against third parties
- Committed misconduct or abuse while using the corporate shield to protect them
- Failed to maintain corporate formalities
- Made business deals or incurred debt they knew the business could not afford to pay
Ways to Prevent Piercing of the Corporate Veil
Fortunately, there are various ways that a business can prevent their corporate veil from being pierced and from stakeholders becoming personally liable for the actions or debts of the business. A dedicated business lawyer familiar with these laws and regulations at Sunridge Legal can help explain the requirements you must maintain to protect yourself, which may include:
Establishing Formalities
The business should establish a proper business structure as early in the process as possible. The formalities depend on the type of the business structure.
Corporations must create bylaws, issue shares of stock to shareholders, and hold annual meetings of directors and shareholders.
LLCs must prepare an operating agreement, issuing membership certificates to members, and hold annual meetings.
Maintaining Separate Financial Accounts
One of the simplest ways to prevent the piercing of the corporate veil is to keep business and personal assets and debts separate. This applies to:
- Checking accounts
- Credit cards
- Lines of credit
- Equipment
- Property
Adequately Capitalizing the Company
One of the reasons why a court may pierce the corporate veil is that the company does not have adequate capital to properly function. Businesses can acquire the capital they need by:
- Investing owners’ personal money
- Raising funds from other investors
- Obtaining a business loan
Following Formalities
Once the proper business structure is in place, the company will need to continue following formalities. These formalities depend on the type of business structure but may include:
- Updating bylaws or the operating agreement
- Issuing shares of stock
- Maintaining a stock ledger or membership transfer ledger
- Holding annual meetings
- Completing annual filings, paying filing fees, paying corporate taxes
- Maintaining a resident agent in the state of formation for legal service
Filing Separate Tax Returns
If required based on the corporate structure, the business should file separate tax returns than the individual owner.
Documenting Business Actions
To better establish the separation between the business and the individual owner, the business should document business decisions and actions in writing. This may include taking such actions as:
- Documenting the occurrence of business meetings and maintaining minutes regarding what happened during those meetings
- Entering into contracts in the name of the business with vendors and others
- Documenting that the business held an initial meeting and annual meetings thereafter for directors and shareholders or members and managers
- Writing down the factors that stakeholders considered when making decisions regarding the business
Advertising Company Structure
Once the appropriate business structure is set up, the business should promote itself with the proper business name and structure so that others who do business with the company are aware of the status. For example, the business can:
- Print busines cards that show the corporation on them
- Include the business structure on invoices you send to clients
- Enter into contracts and leases in the company name
Contact Sunridge Legal for Legal Advice Regarding Piercing the Corporate Veil
Maintaining corporate formalities can be legally challenging and difficult, but it is necessary to avoid the possibility of a litigant piercing the corporate veil. Neglecting to maintain these formalities can bring about significant consequences that could subject you to personal liability for the business’ debts and liabilities. An experienced business lawyer with Sunridge Legal can explain the ways to maintain your corporate status even in the face of litigation. If you are concerned about your business structure and the possibility of another person or entity piercing the corporate veil, consider contacting a knowledgeable business lawyer from Sundridge Legal at [email protected] to learn all of your legal options.
