WHAT IS “PIERCING THE CORPORATE VEIL?”

Bill Wiseacre recently learned the hard way that simply forming an LLC isn’t enough to protect you. (If you missed it, catch up on  Bill Peeks Beyond the Veil). This week, we’re diving deeper into the Uh-Oh moment Bill ran into, so it doesn’t happen to you. You may be wondering – What exactly is the “corporate veil,” and how can you make sure that yours protects you?

If you own a business through an LLC or a corporation, you’ve probably been told that the entity protects your personal assets. Well, that’s mostly true. “Piercing the corporate veil” is the doctrine that lets a plaintiff or creditor, under certain circumstances, reach through the entity and go after the owner’s personal assets.

You see, part of the reason for setting up a business entity is to keep business liabilities separate from personal ones, (the “LL” in “LLC” stands for “limited liability,” after all.) But if something is wrong with how the entity is run, courts may rule that it is unfair to let the owner protect personal assets behind it.

It’s also worth knowing that veil piercing occurs when someone is suing the business and attempting to get to the owner’s personal assets.

THE GOOD NEWS:

Courts generally start from a presumption against piercing the veil, and they reserve it for serious misconduct. The exact test varies from state to state, and some states are more willing to pierce the veil than others, but most courts want to see two things:

  1. That the owner treated the company as such an extension of themselves that it stopped being a truly separate entity; and
  2. That honoring the entity’s separation would shield the owner from accountability for fraud or another serious wrongdoing.

In short, courts step in when an owner uses their business as a shield to escape personal accountability for fraud or has created a very unfair situation.

So, if your business operates as a legitimate, separate entity and you run it honestly, a court is much less likely to pierce the corporate veil.

TEN VEIL-MAINTENANCE TIPS

  1. Make sure you form a business entity in the first place, whether an LLC, a corporation, or some other applicable entity. A plaintiff doesn’t have to pierce the veil if no veil exists in the first place!
  2. Never pay business expenses from your personal accounts or credit cards, and vice versa. The business buys what the business needs, you buy what you need (do not commingle funds).
  3. On the same theme, keep business assets (equipment, vehicles, the office lease) titled in the business’s name, not yours.
  4. Sign contracts in a representative capacity, not just with your name. In other words, “Jane Smith, Managing Member, Acme Widgets, LLC,” not just “Jane Smith.” As an example:

    Acme Widgets, LLC

    By: ______________________

          Jane Smith, Managing Member

  5. Stay in good standing with your state’s business filing office. (This is often the Secretary of State, but it varies; in Maryland it’s SDAT). The specifics vary from state to state, but generally that means filing your periodic reports on time, keeping a registered agent on file, and paying any state fees or penalties. Falling out of good standing can cost the entity its Active status. That doesn’t automatically pierce the veil, but a court could hold it against you.
  6. If you use a trade name (“Acme Widgets, LLC, doing business as Widget World”), make sure the business owns the trade name, not you individually.
  7. Keep the business adequately capitalized. Don’t pull so much money out that the business can’t cover its reasonably foreseeable expenses without a loan from you. Undercapitalization can suggest to a court that the business isn’t really a functioning entity.
  8. Carry adequate insurance: general liability coverage for the business, and professional liability coverage for yourself if you work in a licensed profession.
  9. Avoid personally guaranteeing the business’s obligations (loans, leases, and so on) when you can. Sometimes there’s no way around it, since banks often require a personal guaranty from small business owners. But a personal guaranty means you’ve agreed in writing to be personally on the hook for that debt, which explicitly ducks around the corporate veil.
  10. Finally, and this hopefully goes without saying: don’t commit fraud! It’s hard to commit fraud by accident, and most of what a court would call fraudulent doesn’t pass a common-sense sniff test. If you’re unsure about something, ask a lawyer!

SIDE NOTE: WHAT THE VEIL DOESN’T COVER 

The corporate veil doesn’t protect you from your own wrongdoing, regardless of how well you maintain your business entity. LLC laws keep you from being personally liable for the company’s debts just because you own it, but they don’t protect owners from torts they commit. As a general rule, anyone who commits a tort is personally liable for it. This holds true even if they were acting on the company’s behalf at the time, and even if the company shares that liability.

A doctor is on the hook for their own medical malpractice, an engineer is liable for a negligent design, and your personal assets are on the line if you drive drunk and cause a serious accident in the company van, even if the business might be liable too. In the most technical sense this isn’t veil piercing at all, since the rule is just that the veil doesn’t cover torts: but it sure feels like veil piercing when it happens!

TO SUM-UP:

Treat and run your business like a separate entity, keep its paperwork current, and don’t commit fraud. Most of the time, that will keep the veil between your personal assets and your business completely intact. If you have questions about whether your business is set up in a way that actually protects you, Momentum Law Group is happy to help!

This post is for general informational purposes only and is not legal advice. Reading it does not create an attorney-client relationship. Don’t make big decisions based on blogs you read – talk to a lawyer (even if it’s not us)!

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