What Is Piercing the Corporate Veil?
A corporate veil, the legal shield of separation between a business and its owners, helps to protect individuals from being held personally liable for their company’s debts and legal disputes. Businesses formed as a Limited Liability Company, Corporation, or other form of registered business entity have a corporate veil and therefore safeguard their owners’, corporate officers’, and directors’ personal assets.
However, personal liability protection is not guaranteed if entrepreneurs do something (or fail to do something) that a court considers reason to “pierce the corporate veil.” Piercing the corporate veil (sometimes referred to as “lifting” the corporate veil) is when a court disregards personal liability protection—rendering the persons behind the business entity personally accountable for the business’s debts or legal wrongdoing.
Things can get messy when the corporate veil is compromised. Corporate shareholders, officers, directors, and LLC members may find themselves personally responsible for paying off business debts and may be named in lawsuits. Creditors might go after the owners’ bank accounts, investments, home, vehicles, and other property and assets to satisfy the LLC’s or Corporation’s debt. The effects can create substantial financial and emotional hardship for the business owners and their loved ones.
Note that if an LLC or Corporation has multiple owners, the courts impose personal liability on the individuals who were directly responsible for the company’s negligent, wrongful, or fraudulent actions (innocent owners remain protected from the business’s liability).
Be Aware that Laws Vary
Corporate veil laws vary from state to state, affecting what a creditor or claimant must prove for a court to decide that a business owner’s personal liability protection does not apply and their personal assets may be used to satisfy a debt obligation.
Generally, state laws require proof of three elements to lift the veil of protection and hold an individual liable:
- Unity of interest and ownership (individuals are using the company as an “alter ego” rather than treating it as a separate entity)
- Fraud, inequity, or other misuse of that control
- Damage, injury, or harm occurred as a result of the above
However, no two states apply the same standards, nor do they apply similar standards in the same way. States known for the rigid protection of the corporate veil include Delaware, Nevada, New York, and Texas. Whereas, California and Wyoming have more lax laws that make it easier for claimants and creditors to hold individuals legally and financially accountable.
Examples of Piercing the Corporate Veil
What activities put entrepreneurs in jeopardy of piercing the corporate veil of an LLC or C Corporation?
Some of the practices that could potentially put business owners at risk include:
- Not properly forming the business entity
- Not adequately funding the business
- Failure to maintain the LLC or corporate records required by the state
- Failure to keep business funds separate from personal funds (commingling assets)
- Paying for personal purchases with the business credit card
- Personally guaranteeing a business loan or using personal property as collateral for a business loan
- Not meeting other compliance obligations, like filing an annual report or maintaining a registered agent
- Not following the company’s governance documents (i.e., LLC operating agreement or corporate bylaws)
- Conducting fraudulent activities under the business
- Willfully engaging in activities that put corporate gain over the public good
How to Keep the Corporate Veil Intact
1. Complete the Necessary Paperwork
Business registration and ongoing compliance rules vary by state. Likewise, some compliance requirements, such as licenses and permits, vary by local jurisdiction (e.g., county, city). I encourage business owners to talk with their attorneys and check with state and local government offices to learn which filings, reports, and payments they are responsible for when forming and maintaining an LLC or Corporation.
Examples of entity formation requirements:
- Obtaining an EIN (Employer Identification Number) — also known as a Federal Tax ID
- Filing Articles of Incorporation (if incorporating) or Articles of Organization (if forming an LLC)
- Designating a registered agent
- Adopting bylaws
- Appointing officers and a board of directors
- Maintaining an LLC operating agreement
- Obtaining business licenses and permits
- Filing an initial report
Examples of ongoing business compliance requirements:
- Reporting and paying taxes
- Submitting an annual report
- Renewing licenses and permits
- Holding board of directors meetings
- Holding shareholder meetings
- Holding LLC member meetings
- Recording and maintaining annual meeting minutes
- Renewing registered agent services
2. Stay Out of Legal Trouble
Don’t engage in reckless, illegal, or fraudulent business activities. For example, a court of law might deem it fraudulent on the part of a business’s owners if they entered their company into a contract with a services vendor, knowing their business doesn’t have the funds to pay that vendor. If a lawsuit ensues, those business owners might be held personally responsible and be forced to use their personal funds or property to compensate the vendor.
3. Set Up a Company Bank Account
Keeping personal and business bank and credit accounts separate is critical for maintaining the corporate veil of an LLC or Corporation. Don’t commingle finances! Set up checking, savings, and credit card accounts exclusively for the LLC or Corporation to help ensure personal assets stay independent from those of the business. Owners should use company checks and company credit cards only for business purchases. That will help prevent shades of gray regarding the use of business funds.
4. Avoid Personally Guaranteeing Business Loans
If a business owner signs on to personally guarantee a business loan, they assume personal liability for that debt. If their company cannot make its loan payments, the LLC member or corporate shareholder will be on the hook to ensure the money is repaid. Sadly, that could result in losing a home, retirement savings, money set aside for their kids’ education, and other personal assets.
5. Keep the Rules of Engagement Crystal Clear
Explicitly spell out in all documents and communications that customers, vendors, suppliers, project partners, etc., are making transactions with the business entity. Business owners should use their legal business name and other relevant details on company paperwork and correspondence, such as proposals, contracts, invoices, sales receipts, marketing materials, and other documentation.
6. Be Vigilant
Entrepreneurs should make every effort to maintain a separation between their personal interests and those of their company. If a business faces financial or legal issues, any lapse in business compliance or other activity that muddies the waters could result in the company’s owners being held responsible. And that can have disastrous ramifications for those individuals and their family members. I strongly recommend that business owners talk with a knowledgeable attorney and a tax professional to get information and guidance so they understand their obligations.
Read More About Protecting You and Your Business
- When Personal Liability Protection Doesn’t Work for Corporations and LLCs
- Obtain Asset Protection for Your Business
- Does a Sole Proprietorship Need Liability Insurance?
- How to Keep Your LLC or Corporation in Good Standing
Strengthen the Corporate Veil with CorpNet’s Help
Tens of thousands of entrepreneurs across the U.S. turn to CorpNet for help with fulfilling their state filing requirements when starting their businesses and keeping them compliant. Compliance helps strengthen the corporate veil, giving business owners peace of mind that their personal assets are protected.
