Piercing the Corporate Veil
Piercing the corporate veil refers to a legal event that eliminates the barriers between the rights and duties of a corporation and those of its individual shareholders or owners. In most instances, a corporation is treated as a separate entity, much the way a trust is viewed as a separate – and safe entity – in an estate planning dynamic.
One of the primary attractions for designating a corporation or a limited liability company is its ability for the owners to maintain the debts and rights completely removed from and without compromising their personal debts and assets. It can protect those individuals should the company become unable to pay its creditors. There are times, however, when courts will bypass those protections and hold the owners and shareholders personally liable for those business debts. This is when “piercing the corporate veil” occurs.
In recent years, we’ve seen more instances of piercing the corporate veil. With so many problems common in hard economic times, such as what the nation experienced during the recession, many business owners found themselves having to make tough calls and with thousands of companies shutting down, the last thing they needed was to take on the debts of their business. In fact, many had already sunk many of their personal assets into preventing the loss of the business, even though they knew it was not the best decision (and in fact, this are the types of moves that lend to courts’ lifting the veil). They simply wanted to maintain their company because they were certain they could weather the financial storm. Unfortunately, many were sued and in some cases, the courts allowed those creditors to seek not only any assets associated with the company, but they were allowed to go after the business owner’s personal assets.
From a different perspective, those companies that did sue were also trying to keep their companies afloat. Upon learning a business had closed, they learned they had no recourse unless the courts allowed lawsuits against the owners versus the corporation.
If a court decides to “pierce a company’s corporate veil”, any owners or shareholders are then left open for even more legal woes. They can be held personally responsible – up to an including having their houses, bank accounts or any other assets left vulnerable. That said, courts have historically imposed personal liability on those responsible for the wrongdoing. It’s not at all common for any court to name others that appear to have been removed from any kind wrong actions.
Another scenario: if owners do not maintain a formal legal separation between their personal financial dealings and their business, the court could decide that the corporation is not legitimate. This is why it’s never a good idea for a business owner to drop his own assets into his company, even if it’s struggling. If the owner has been paying personal bills from the company’s checking account or ignoring the legalities associated with defining a corporation or LLC, the courts can—and often do—rule that the owner voided the protections offered by the separate entities.
But what happens if a business owner operated from a fraudulent or otherwise wrong perspective? Let’s say he took out loans he knew he would be unable to repay or perhaps he fudged the profits or losses – then what? Again, the courts could decide that not only did the owner act illegally, or at a minimum, unethically, and then hold the owner personally responsible.
If you’re considering setting up a corporation or LLC, we encourage you to give us a call to explore your options and responsibilities so that you’re not at risk of piercing your own corporate veil.