When forming a limited liability company (LLC) or corporation, business owners often choose these entities to limit their personal liability for the debts and liabilities of the business. However, there are certain formalities that must be followed in order to maintain this limited liability protection. If these formalities are not followed, a court may pierce the corporate veil and hold the members, shareholders, or other owners personally liable for the debts and liabilities of the business.
What is Piercing the Corporate Veil?
Piercing the corporate veil is a legal doctrine that allows a court to disregard the corporate entity and hold the members, shareholders, or other owners personally liable for the debts and liabilities of the business. This doctrine is typically invoked when the members, shareholders, or other owners have not followed the formalities required to maintain the separate existence of the business entity.
How to Avoid Piercing the Corporate Veil
There are a number of things that business owners can do to avoid piercing the corporate veil. These include:
- Forming the business entity properly. This includes filing the necessary paperwork with the state and obtaining a certificate of formation or incorporation.
- Keeping separate bank accounts and records for the business. This will help to demonstrate that the business is a separate entity from the owners.
- Not commingling personal and business assets. This means not using personal assets to pay for business expenses or vice versa.
- Holding regular meetings of the board of directors or members. Minutes of these meetings should be kept.
- Issuing stock certificates or membership certificates to the owners.
- Keeping proper documentation of all business transactions. This includes contracts, invoices, and receipts.
- Obtaining insurance for the business. This can help to protect the owners from personal liability in the event of a lawsuit.
By following these tips, business owners can help to protect themselves from personal liability and avoid piercing the corporate veil.
Additional Considerations
In addition to the above, business owners should also be aware of the following factors that may increase the risk of piercing the corporate veil:
- The size of the business. Smaller businesses are more likely to have their corporate veil pierced than larger businesses.
- The amount of personal assets that the owners have invested in the business. The more personal assets that the owners have invested in the business, the more likely it is that a court will pierce the corporate veil.
- The degree to which the owners have commingled personal and business assets. The more that the owners have commingled personal and business assets, the more likely it is that a court will pierce the corporate veil.
- The degree to which the owners have failed to follow the formalities required to maintain the separate existence of the business entity. The more that the owners have failed to follow the formalities required to maintain the separate existence of the business entity, the more likely it is that a court will pierce the corporate veil.
If you are considering forming a business entity, it is important to consult with an attorney to discuss the risks of piercing the corporate veil and how to avoid them.