When you create a limited liability company (LLC) or a corporation, minimizing risk is one of the key factors for your decision. Business owners limit their liability when they create a business entity that separates personal assets from business assets, thereby limiting exposure to risk on both fronts. However, business owners can lose this foundational characteristic of LLCs and corporations if a creditor can “pierce the veil.” Every day, many business owners unknowingly put themselves and their company at risk of piercing the veil, and that’s assuming their corporate documents aren’t working against them from the beginning.
What Is Piercing the Veil?
Piercing the veil occurs when a court is persuaded to disregard the separation between the business entity and its owners. When this happens, business owners lose their corporate protections, and creditors can target the owner’s personal money and property to satisfy the company’s debts. A judgment that pierces the veil can be devastating for both the business and its owners. Therefore, it should be avoided at all costs.
What Activities Can Result in Piercing the Veil?
Here are the most common circumstances that result in piercing the veil:
- Commingling funds and other identity-blurring activities. The most common way business owners put themselves at risk is by commingling their business funds with their personal funds. Courts interpret commingling of business and personal money as a failure to keep the legal identities separate. This doesn’t mean you can’t pay yourself or inject cash into your company. Rather, commingling of funds involves paying for personal debts and assets directly from the company’s account and vice versa. Courts say that if you as a business owner did not recognize or treat your business separately, you should not be able to hide behind the shield of limited liability.This commingling is often characterized by a lack of corporate or LLC records tracking the specific action in question. You must maintain records and practices that keep your business’ property and money separate from your personal assets. Leigh Hilton, PLLC has years of experience giving clients the tools they need to protect themselves and their company.
- Intentional or grossly negligent conduct by business owners. Courts will pierce the veil if they find that a business owner’s behavior was extreme and directly caused the harm for which the business is being sued. For example, suppose a business owner delivered products in the company car and caused a car accident. If the plaintiff can prove that the business owner was driving while intoxicated, the court might strip away the company’s limited liability. In such cases, plaintiffs would likely seek damages against both the business and its owner and would probably win.
- Fraudulent behavior. Business owners can lose their limited liability protection by engaging in fraudulent behavior. Fraudulent activity sometimes leads to piercing the veil when the owners have created the company to cover up unjust actions. Under such circumstances, courts have held that failure to pierce the veil would lead to injustice.
- Undercapitalization. Undercapitalization itself will not necessarily result in the loss of a company’s limited liability protection, but courts will see an underfunded business as a factor that supports piercing the veil. At a minimum, a business should try to maintain an adequate amount of capital to support its operating activities. Intentional lack of capital, coupled with one or more of the other factors discussed, increases the likelihood that a court will decide to pierce the veil.
- Failure to adhere to corporate or legal formalities. Finally, a common mistake of small business owners is the failure to follow statutory requirements in every state where the company does business. State law dictates what LLCs and corporations must do to remain in good standing. Failure to know and follow these requirements will result in the entity’s suspension, leaving the business owners exposed to personal liability for the company’s debts. As a business owner, you must understand state laws for your business and how those laws impact your liability shield.
It is crucial to take the necessary steps to protect you and your business from veil piercing. Our team of experienced attorneys will work tirelessly to help you structure, maintain, and protect your business in the right way. Schedule a virtual consultation with our office to assess your current risk and enact legal strategies to protect your limited liability.