Piercing the Veil -- How to Protect Your Limited Liability Status
While there may be many reasons for forming a business entity of one type or another, one of the most important reasons is the limited liability of individual owners for the debts and obligations of the company. Unlimited personal liability for the debts and obligations of the business exist for general partners in a partnership and sole proprietors. Owners of limited liability entities, such as corporations or limited liability companies, on the other hand, have personal liability for the debts and obligations of the business only to the extent of their invested capital and to the extent that they may have assumed personal responsibility for the same.
The purpose behind limited liability protection is to promote investment and commerce by allowing owners to limit their risks. While owners may from time to time choose to personally guarantee debts, unfortunately, all too often limited liability protection can be unwittingly lost as owners, officers and/or directors find out from a judge that they have become personally liable for the debts and obligations of the company. Courts impose this personal liability by “piercing” the company veil. The Court decides that the company and its owner(s) are really one in the same.
What can owners, directors, and/or officers do to help ensure the Courts will treat the company as a separate entity and not as the alter ego of the owners? While no guarantees can be made, what follows is a list of relatively easy steps that can be taken, and, if faithfully observed, will go a long way in shielding owners from personal liability:
Make sure your company has been properly established.
File your annual reports to keep the company in good standing. Many states will dissolve a company after a period of time for failure to file its annual report.
Ensure that the business was initially capitalized and continues to maintain adequate capitalization.
Create good company records – document with minutes all meetings and obtain signed consents where appropriate.
Hold regular company meetings.
DO NOT PAY PERSONAL DEBTS WITH COMPANY FUNDS.
Maintain a separate bank account for the company -- personal monies and company monies should not be co-mingled.
Limit loans between the owners and the company. If loans are made, ensure that proper documentation exists and make payments in accordance with the terms of the loan.
Sign contracts in the name of the company and not in your personal name.
Always use the correct company name, on letterhead, in your advertisements, and in your other business dealings – make sure customers, suppliers, etc. know who they are dealing with.
The smaller the company the more difficult some of these tasks become. However, in small single owner businesses or home-based businesses, observing the above suggestions is even more important. Remember that if you treat the company like a separate entity, the courts will be much more likely to do the same. Running a business can be a complex matter. If you have questions make sure you seek competent help in finding the answers.
