You've Incorporated but Are You Really Protected?

Piercing the Corporate Veil – Consensual Creditors

So you have formed your corporation or your limited liability company and are now conducting business. Of course you are hoping things are problem free. But, if you are like most small businesses, you formed a separate company to protect your assets in case something goes wrong. But just how protected are you?

In some cases, small business owners have a false sense of security that their personal assets are protected by the existence of a business entity. But, the truth is there are other steps that must be taken to prevent creditors or plaintiffs from reaching your home, savings accounts, and other personal assets in the event of a problem. This is an overview of factors that should be considered in protecting your personal assets from business problems. 

A corporation is an entity separate from its owners. It is a legal person but is owned by shareholders. Generally, the shareholders are not individually liable for its debts.

However, there are important exceptions that may allow creditors to access the personal assets of the shareholders. 

The first is pretty straightforward. It applies when the shareholders are guilty of fraud. There, an alter ego exception applies. If fraud is proven. the courts may allow the defrauded creditor to access the shareholders' assets to satisfy a debt. 

In the absence of fraud, alter ego exception applies when corporate formalities have been disregarded to the extent that corporation ceased to be distinguishable from its shareholders.

Factors to be considered when piercing the corporate veil:

1.    commingling of corporate and shareholder funds

2.    failure to observe statutory formalities

3.    undercapitalization

4.    failure to provide separate bank accounts and book keeping records

5.    failure to hold regular shareholder and director meetings

6.    ownership of all shares by a single shareholder

Some factors weigh more heavily than others under particular situations. There is no magic bullet here. The court will consider the totality of the circumstances!!!

The factors above apply mostly to corporations because the case law on corporations is long and extensive. Limited liability companies are still new but there are indications that the veil of an LLC may also be pierced under similar circumstances. 

The key is to be careful with your business operations. Consult your attorney to ensure your operational practices are not destroying the advantages you may otherwise be entitled to by owning a business entity. 

For additional information on this article, contact the attorneys of Dassau & Coleman.