The whole goal behind registering your business as a Limited Liability Company (LLC) or a Corporation is to take advantage of the protections offered to individuals who own such entities, such as shielding oneself from personal liability pertaining to debts of the business, however protection is not absolute there are different instances where you lose protection.
The general rule when it comes to corporations and LLCs is that they are separate and distinct from the actual members and shareholders (think humans). However, this distinction can be removed, leaving business owners personally liable for their companies’ liability. When this happens the term piercing the corporate veil is used.
SO WHAT DOES IT TAKE TO PIERCE THE CORPORATE VEIL?
SIPHONING AND CO-MINGLING OF BUSINESS AND PERSONAL FUNDS
This is typically likely to occur when a person owns a small business, solo business or family run business where it is enticing to use the company account or card for personal items.
Janet has a cute little flower shop called Wall Flowers, LLC. It is Christmas time and Janet figures she can use her company business card and funds to go shopping for Christmas gifts for her kids. After all, the money is hers anyway and goes towards her salary so she is good. Wrong. This is a lack of separation between the entity and owner. Janet is better off paying herself and then using that personal money to shop for her kids, so she insulates herself from the entity’s debts.
INSOLVENCY AND INSUFFICIENT CAPITAL
A creditor may attempt to pierce a company’s corporate veil when they have insufficient funds to satisfy the creditor’s claim. Note that not all undercapitalized or insolvent companies will have their corporate veil subject to piercing. It would really depend on the debtor creditor relationship and facts specifically related to their case.
Dolinka Inc. is a daycare school. They have undertaken a large expansion by purchasing more buildings in the hopes of adding more branches to their establishment. However, they are struggling with meeting their current financial obligations with the current daycare they have. If there is a lawsuit brought against them, and Dolinka Inc., shareholders or managing member was aware of this insolvency, before they took on the large expansion, they could be subject to a piercing of their corporate veil.
FAILURE TO ADHERE TO CORPORATE FORMALITIES
In a corporation or an LLC, you have several organizational formalities that range from detailed minutes of the company meetings and books to maintaining specific officer positions to citizenship status, so a failure of observing any one of those formalities makes it easy to have your veil pierced. The reason why here it would be easy to pierce the corporate veil is because if a business is not abiding by required corporate formalities, it renders the formalities meaningless, therefore no separation of entity and person.
Ryder Inc. is a new S-Corporation and has 500 shareholders, some of which are not United States Citizens or Permanent Residents. This could render the corporate formalities meaningless because generally an S-Corp requires that a corporation cannot have more than 100 shareholders and that all shareholders must be United States Citizens or Permanent Residents.
In conclusion and, notwithstanding all of these examples, these are not hard or fast rules as to what could cause a company’s veil of protection to be pierced as most courts will look at the situation on a case by case basis.
The advantages of having your small business registered as a corporate entity or limited liability company certainly outweigh the disadvantages, there are just certain steps you must take to keep your company running smoothly and protect your investment. It is important that when you don’t understand the intricacies of entity maintenance that you seek counsel from a knowledge attorney who can help you reduce the risk of losing protection from your business.
Ayesha Chidolue is the Managing Attorney at The Chidolue Law Firm. We are a boutique law firm that acts as a trusted legal advisor to small business owners. Attorney Chidolue is licensed to practice law in the states of Florida and New York. At The Chidolue Law Firm, we can guide you through organizational design and legal advice and audit of your current business practice. If you need legal assistance with your business, we will be happy to assist you. Please contact us at firstname.lastname@example.org or call us at 407-995-6567.