First, let’s start with the concept of a corporation or limited liability company (LLC). Because they are in and of themselves “entities,” corporations and LLC’s have a legal existence – rights and liabilities distinct from their owners. So, the officers and shareholders are normally not personally liable for the debts and actions of the corporation or LLC. But …
Courts have said that, in some circumstances, corporations and LLC’s will be disregarded, and the “corporate veil” – the shield between the entity’s creditors and the owner’s personal assets – can be pierced to hold individual owners personally liable for the conduct or debts of the entity. Thus, piercing the corporate veil is something that every business owner should be aware of.
In order for the court to authorize piercing the corporate veil and hold the individuals (or some of them) personally liable, a litigant must establish that there is (1) “unity of control” and (2) a fraud or injustice if the corporate form is recognized.
To do this, the litigant going after the individuals must show to the court the facts that support his contention that the corporate form should be pierced. Factors include intermingling of funds, failing to abide by corporate formalities, using the corporate form to confuse or defraud, being undercapitalized or careless about the separate status of the corporate entity. Keep these factors in mind, since if you’re a business owner, you’ll want to address these factors.
One of the most common things we see is the failure to keep the corporation separate from the individual. Keeping the corporation separate means obtaining a tax identification number for the entity, opening a bank account for the entity, and keeping the entity’s finances separate from the individuals. Commingling personal funds with the entity’s funds is never a good idea.
Another common issue we see, and something the courts consider when piercing the corporate veil is the failure to maintain corporate formalities. Maintaining the corporate formalities includes things like having an operational document (Operating Agreement for LLC’s, Bylaws for a corporation, etc.), keeping records of meetings, and filing annual reports (if necessary). We often see instances where a person has formed their own LLC, but never adopted an Operating Agreement. This failure to have an Operating Agreement may be a factor the court looks at when determining whether to pierce the entity’s corporate veil.
In order to preserve the protections that your corporate entity or LLC affords you and avoid a court piercing the corporate veil, do not intermingle funds, abide by the corporate formalities and treat the entity as completely separate from you as an individual. The attorneys at Powers & Neal are experienced in helping business owners navigate the legal landscape and can offer practical solutions for all business owners. Call Powers & Neal today at 480-699-7992 to discuss how our attorneys can serve you and your business.