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| "Piercing the Corporate Veil" |
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Did you know that the act of forming a corporation, in itself, does not protect you?
Most people incorporate primarily for liability protection. When you form a corporation, limited liability company, or similar business entity, a "corporate veil" is created between your personal assets and your business. When properly managed, corporate veils provide significant personal liability protection against lawsuits, creditors, and other disputes.
However, to prevent "Piercing the Corporate Veil" you must do more than merely form a business entity and register it with the state. There are a host of ongoing governance requirements and formalities for business owners. Business owners must keep the rules of corporate governance to prevent "Piercing the Corporate Veil". |
What is "Piercing the Corporate Veil"?
 The "corporate veil" refers to the separate legal existence of a corporation, or an LLC, that usually insulates the owners of the entity/company from liability for the company's actions or obligations. Maintaining the "veil" will help to shield the company's owners from personal liability for claims or lawsuits against the company.
"Piercing the corporate veil," or "piercing the veil," means that this liability protection is disregarded, and the personal assets of owners are at risk in a judgment against the business. |
Are You Protected?
One of the biggest advantages to incorporating a business is that the principals of the corporation can enjoy broad protection from being held personally responsible for the debts and liabilities of the corporation. That is, creditors can reach the corporation's assets, but once those assets are exhausted they cannot ordinarily also reach the personal assets of the owners or shareholders of the corporation.
However, the lawsuit protection features of the corporation will be available only if the integrity of the corporation as a separate and distinct entity, apart from the individual, is respected by a court and by the Internal Revenue Service.
In matters involving a lawsuit by another party, especially if a corporation has no significant assets, the plaintiff will attempt to convince the court that the corporate entity should not be respected and that the principals of the company should be personally liable. In these cases, the plaintiff is attempting to pierce the corporate veil in order to obtain a judgment against the principals, who may have personal assets sufficient to satisfy a judgment.
There are many reported cases on this topic, and the outcome is usually determined by whether the corporation carries out its business and looks and acts the way a corporation should.
 If the principals treat the corporation and hold out the corporation to third parties as a separate and distinct entity, the court will usually uphold the status of the corporation and will not find personal liability.
However, if various corporate formalities are not consistently observed, the corporation will be disregarded and the individuals may be held personally liable.
One of the major problems with the corporate format for small businesses is that as a matter of course the shareholders, officers, and directors will be named in any lawsuit against the corporation. The plaintiff will attempt to pierce the corporation or will argue some theory to make the defendants responsible.
In a significant number of these cases, when there is a judgment against the corporation, the court will disregard the legal protection of the corporation and will hold the defendant shareholders, officers, or directors liable.
It is highly recommended that if you are a principal shareholder or officer/director of a corporation, you use a proper asset protection plan to shield your personal assets from the potential liability associated with the corporation. |
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Piercing the Veil Can Happen When:
- Corporate debt is knowingly incurred when the company is already unable to meet debts or discharge liabilities
- Required annual shareholders or board of directors meetings are not held, or other Corporate-Formalities are not observed;
- Corporate records, especially minutes of directors meetings, are not properly or adequately maintained;
- Shareholders remove unreasonable amounts of funds from the corporation, endangering its financial stability
- There is a pattern of consistent non-payment of dividends, or payment of excessive dividends;
- There is a general commingling of corporate activity and/or funds and those of the person or persons who control the corporation;
- There is a failure to maintain separate offices and the company has little or no other business, and is only a facade for the activities of the dominant shareholder who is in fact, the corporate "alter ego."
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Factors Courts Consider...
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?
Or, were the procedures not followed, was the corporation dependent on property or assets of a shareholder which it did not technically own or control, or were the corporate finances commingled with those of its shareholders?
Individual Control - What amount of financial interest, ownership and control did the principals maintain over the corporation? Was there any manipulation of assets or liabilities to concentrate the assets or liabilities?
Personal Use - Did the principals use the corporation to advance personal purposes?
It is important to note that not all of these factors need to be met in order for the court to pierce the corporate veil. Some courts might find that one factor is so compelling in a particular case that it will find the shareholders personally liable. |
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Corporate Veil Protection Checklist
Protect your personal assets!
Download the checklist now and make sure that you are in compliance! | |
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