What Is "Corporate Veil" And How It Can Be Pierced
Posted: Saturday, November 06, 2010
by Alex Zehnbacht
MyUSACorporation.com
Protecting Your Assets
If you are a business owner, one of the most significant reasons to incorporate or form a limited liability company ("LLC") is to protect your personal assets from a business creditor's claims against your company. This ability of a properly-formed and maintained company to shield its owners from personal liability is sometimes referred to as the "corporate veil." Under certain circumstances, however, business creditors may be able to successfully make a claim against a business owner's personal assets or "pierce the corporate veil."
Most veil piercing circumstances occur because a business owner has either failed to abide by the legal requirements for operating a business or because the owner did not clearly separate his personal and business assets. Here are some guidelines for establishing your business and conducting it in a way that makes "piercing the corporate veil" less likely.
Separating Personal and Business Assets
If you are the owner of a corporation or an LLC, you are obligated to maintain a legal separation between yourself and your company. If you fail to do this, you risk creditors claiming that your company is merely your "alter ego" - a mere shell of your "self". Your personal assets may then become vulnerable to business creditors. These are some of the steps to take in order to separate business and personal assets:
First, not only should you maintain separate bank accounts for your business and personal finances, but you should never use company funds to pay your own personal expenses. If it becomes absolutely necessary for you to provide personal funds to pay employees or other pressing business expenses, document the additional funds as either a loan or an additional investment into the company.
Second, directors, officers and controlling shareholders (or members and managers of an LLC) have a general fiduciary duty of loyalty and integrity that should govern all their corporate conduct. This means that as an owner of a company you should always be making decisions that are in the company's best interest. An opposite behavior would be taking actions that benefit you personally to the detriment of the company you own. If an owner violates this duty either on purpose (in bad faith) or by not paying proper attention (negligently) he may be personally liable for any consequences of his actions on behalf of the company to a business creditor.
Third, it is important to maintain adequate business capital. If your business is deliberately undercapitalized (cannot afford to pay for its operational expenses), you may become financially responsible for legal claims against your company.
To guard against some of the mistakes listed above, companies can sometimes obtain "Errors and Omissions" insurance coverage that would insulate directors and officers from legal action caused by their conduct while representing the company.
Observing Corporate Formalities
Every state has certain requirements for corporations and limited liability companies. Filing an annual statement (or annual report) is one of these requirements that applies to both types of entities. An annual statement allows the state to keep correct data about your corporation or LLC. If you do not submit annual statements and pay the required fees on time, the company can be administratively terminated. If your company is dissolved, you will lose limited liability protection. While LLCs have fewer requirements, corporations are also subject to other formalities that include holding an organizational meeting to elect officers, adopt bylaws and issue stock.
A company should also schedule annual meetings of shareholders and should keep minutes of the annual meetings with the company records. Corporations should also keep a ledger that details all shares issued to shareholders, and how much each share is worth. The bylaws detail the manner in which the company will be operated and are one of the corporation's most crucial documents.
Corporations should keep records of all payments made, payments received and all invoices and statements. You should also keep profit and loss statements and balance sheets every year. In addition, corporations should maintain documentation for business loans and the repayment terms.
Guidelines for Limited Liability Companies
LLCs have fewer formalities to worry about. But it is advisable for LLCs to observe many of the same safety measures to prevent business owners from being held personally liable. Practical guidelines include holding an initial organizational meeting, adopting an operating agreement, maintaining documentation of all business decisions, documenting finances and encouraging all of its members to have an annual meeting, minutes of which should be recorded and kept.
While a single act may not lead to piercing the veil, numerous mistakes could be costly, leading to a situation where an owner becomes personally liable for claims against the business. Different states' laws provide different levels of protection to business owners. States like Delaware, Nevada and Wyoming are very protective of the limited liability, making it very difficult for claimants to pierce the corporate veil and reach personal assets of the owners. Other states are much less hesitant to transfer the liability of the business onto its owners. This, along with favorable state tax rates, is what makes Delaware, Nevada and Wyoming so incredibly popular when it comes to forming companies.
Remember, when you form an LLC or a corporation, liability protection is one of your most important goals -- observe the simple guidelines listed above so you do not lose this valuable feature of your company.
---
Alex Zehnbacht is an entrepreneur with over 8 years of experience in start-ups and business consulting and one of the founders of MyUSACorporation.com, an online business dedicated to help entrepreneurs with all their business filing needs. He has helped thousands of clients to incorporate their businesses, form LLC, obtain various business licenses, and much more.
This Article has been viewed 225 times. (Not updated in real-time.)
Top-level comments on this article: (1 total)Dick owns a New York based Sub S Corporation which is invested in TIC investments that pay rental distributions to Dick's Holding Corp. (DHC). Dick is the sole shareholder of DHC and DHC has a long history of owning property. His daughter is the Sec./ Treasurer while he is the President. They recently converted to Sub S (in 2005) from a Sub C after Dick's Mom (who had preferred shares while Dick had common shares) retired and asked to be bought out. DHC sold its asset (a building) and invested in TIC's. There is another Corporation that was started in 2000. It is a consulting corp. Dick's Consulting Corp. (DCC). It is a Sub S. Dick's wife owns 55 shares and is the President, their daughter (from DHC) owns 10 shares and is not an officer, and another daughter also owns 10 shares and she is a Vice President. Dick, himself is also the Sec/Treasurer of DCC and owns 25 shares. Annual Corporate meetings are held each year. DHC pays DCC consulting fees. DCC has a health benefit plan for Dick, his wife and their 18 year old son. The health plan is offered to all officers of DCC, but the daughter (VP) in DCC has declined coverage as well as the other daughter (just a shareholder and not entitled). DCC has had a few opportunities to expand its consulting sphere (documented) but were unsuccessful and remains with DHC as its sole client. There are separate bank accounts, not only by DHC and DCC but by each of the TIC accounts within DHC. Each separate TIC pays its rent to an individual account which periodically transfers the rent to DHC which then distributes its consulting fees to DCC and repays loans to Dick and now (since loans have been repaid) is about to distribute money to Dick. DCC uses its fees to pay for health insurance for Dick and/or it officers and distributes a very small management fee to Dick, his wife and his daughter (all officers) of $150- $200 a year.
Two questions:
1) Being DHC is a Sub S, can the monies DHC receives from its rents (for liability concerns) be distributed to Dick with no designation, since it is already accounted in the IRS Taxable Income as Sub S income?
2) Is DCC justified in having a health care program and can the Ins. company pierce the corporate veil, (claiming that DCC is a sham and is not entitled to Insurance at its discounted "Small Employer" rate) by using the Alter Ego Piercing and disclaim all claims previously paid by the Ins. Co. -- leaving Dick and his wife to pay for ALL past medical claims?
We want your comments! If you can read this, you don't have javascript enabled, so you can't use this comment system. Please enable javascript.