Like most owners, when you started your small business you probably did not know much about corporate veils. Eventually, you learned enough to know you needed one. So you got a lawyer, did the paperwork, paid the money, and became a corporation or limited liability company. Then you put the paperwork somewhere and forgot about it, believing you were now covered against being personally liable for the debts and obligations of the business.
But, you, like most owners, would be mistaken. You are not as protected as you think you are. In business the most common legal cases are disputes about a company’s legal liability, which they routinely lose. Let us look at why they do.
What is a corporate veil supposed to do?
It was designed to shield people (i.e. shareholders, officers, directors, owners) from the debts and bad acts of the company. The business is a separate and distinct entity from the owner. The owner, even though he acts for the entity, cannot be held liable for the business’s obligations or actions. Claimants and creditors can only go after the company, not the people involved with it.
What is piercing the corporate veil?
The corporate veil is not a get out of jail free card. If you are not following the rules or laws the courts can pierce, or disregard, the veil and hold you personally responsible for the debts and bad acts of the company. Once declared personally responsible the shareholder’s, officer’s, director’s and owner’s assets (bank accounts, property, investments, etc) can be used as restitution for the improper behavior of the business.
What factors contribute to piercing the corporate veil?
The short answer is – it depends. There are many factors a court will consider before it will pierce the veil. Here are a few of the main ones they look at.
Intent to deceive – You cannot knowingly behave dishonestly, wrongful or fraudulently and be shielded by the veil. For example: If you take on debt you have no means to or intention of paying, the creditor may be able to pierce the veil and you will be personally responsible for it.
Alter ego – The business is separate from you, it is not a part of you. It has limited liability status, you do not. The assets of the company belong to the company, not you. There should be a rigid line between business and personal money. When you commingle assets you tear down the veil.
Identities of subsidiaries – Any companies you own must have separate identities and not share resources (i.e. bank accounts, facilities, financing, contracts, management, employees). Courts look at the purpose for having multiple companies – deception, insufficient capitalization to evade creditors, tax avoidance, fraud, etc.
Not following regulations – If the formalities (i.e. updating by-laws, annual reports, stock or membership ledgers, annual meetings, election of officers) are not followed it can be seen as an attempt to achieve limited liability status without any plan to form a valid company.
Most small business owners do not know what they need to do to maintain their corporate veil. This comes from a lack of knowledge, rather than a desire to deceive. Unfortunately, claiming ignorance will not protect your personal assets. Take the time, spend the money and contact a business attorney to make sure you are following all the rules. A lot of small business owners are not protected. You should not have to lose your home to find out you are one of them.
At Cogent Analytics, we never stop looking for ways to improve your business and neither should you. So, check out some of our other posts for helpful business information:
