Many owners of incorporated business entities believe that their personal assets are protected against the debts or obligations of their business, no matter what. While limited liability is one of the principal characteristics of business entities, simply incorporating a business is not enough to protect against personal liability. Once a business is properly incorporated as a separate legal entity, business owners must operate their business as such and follow all the required corporate formalities throughout its existence in order to create a shield, known as “corporate veil”, against personal liability.
Courts across the country recognize a doctrine known as “piercing the corporate veil” which most often arises in connection with a creditor’s attempt to hold corporate shareholders or LLC members personally liable for the debts of their business entity. Courts are likely to allow the piercing of corporate veil and hold the business owners personally liable, if the business entity is found to be simply the “alter ego” of the owners, or when owners disregard the required corporate formalities to the extent that the business entity is no longer distinguishable from its owners.
Here are some practical tips to reduce the likelihood that the corporate veil of your business entity will be pierced:
- Make sure your business is incorporated correctly.
- Have a separate bank account for your business on its name.
- Do not commingle or freely transfer funds between your business account and your personal account, or between your parent company and its subsidiaries.
- Do not pay your personal expenses out of the business checking account.
- Capitalize your business adequately.
- Do not hold the business assets in your name. Hold them in the name of your company.
- Do not provide personal guarantees.
- Sign contracts and other legal documents as an agent for your business entity. Do not simply sign your name without reference to your business entity.
- Observe required corporate formalities such as conducting shareholder and Board of Directors meetings after giving proper notice, keeping minutes of the meetings, issuing stock certificates, etc.
- Follow formalities regarding loans to shareholders; have them properly authorized and documented, have arms-length interest rate and terms, and require repayment.
- Do not pay loans from shareholders before unrelated creditors.
- Make the type of your business entity known via business card, website, invoices, letterhead, etc.
- Do not let Parent Corporation control a subsidiary’s operations. Have separate officers and directors for each.
- Timely file the annual report with the Secretary of State.
- File corporate income tax returns.
Basically, if a court cannot separate what belongs to your business from your personal belongings, and if you cannot provide any proof that all the required corporate and other formalities have been followed, it may be deemed that you are acting more like a sole proprietorship than as a corporation or an LLC, and therefore, you may lose your limited liability protection. Consult with a CPA or an attorney to ensure that your corporate veil is strong.