Normally, those who own or manage a corporation or LLC are not personally liable for business debts. However, there are circumstances where that limited liability is lifted. Those instances are referred to as “piercing the corporate veil.” In other words, the shareholders, members, and owners of the corporation are considered to be personally responsible for the liabilities of the business.
Limited Liability and Business Debts
As stated, a corporation or limited liability company (LLC) provides limited liability protection to its owners, members, etc. in that it is treated as a separate entity in the eyes of the law. Put simply, the business, not its owners, bears the responsibility for its own debts.
If the business incurs a debt that it cannot pay, then creditors cannot usually seize the assets of its members/owners/shareholders in order to satisfy that debt. That means if your business goes under, your personal assets—house, bank account, investments—are safe.
However, there are situations where that protection may be lifted.
When the Corporate Veil Might Be Pierced
A court might pierce the corporate veil if the following circumstances apply.
First of all, most courts will only pierce the corporate veil if there is some form of misconduct. Poor business management, reckless borrowing, acts of dishonesty, or other wrongful actions may lead a court to conclude that the company was engaged in fraud.
Significant costs incurred
Secondly, there is typically a significant debt owed or an unjust cost incurred for other parties. In essence, the debt is large enough for those who were defrauded—such as lenders or other businesses—to warrant collection by any means possible. If the costs involved aren’t significant, it likely won’t be cause for much concern.
No separation between owners and their company
The final factor that must be at play is a lack of separation between the owners and their company. In order to be considered a separate entity, a corporation or LLC must be structured properly and its owners have to follow specific formalities. Actions such as using business funds to pay for personal expenses or failing to record minutes for meetings could lead a court to conclude that the business entity didn’t actually exist, thereby leaving the owners liable.
Protecting Yourself and Your Company
If you run your business properly and follow all the necessary formalities, the good news is that you’re unlikely to have your corporate veil pierced. However, that’s the key to protecting yourself—following the formalities and maintaining a strict legal separation between your company and its owners.
Some basic tips to follow include:
- Holding annual meetings between directors and shareholders/members.
- Keeping detailed minutes of important decisions.
- Adopting company bylaws and hold members, officers, etc. accountable to them.
- Maintaining a separate bank account for your company.
- Not comingling personal and business assets or funds.
- Investing adequate capital in the business from the outset.
- Never personally guaranteeing payment of debts.
- Avoiding illegal or fraudulent acts.
- Including proper labeling such as Inc. or LLC in your business’s name.
A corporate attorney can also help you structure your business in a way that ensures limited liability status. Hart David Carson LLP specializes in corporate law, and we can help you if you have any questions.