LLCs and corporations are important tools in our legal and business system. These legal entities allow business owners to protect themselves from personal liability in many cases. This encourages entrepreneurs and business owners to take risks since liability is contained within the business itself. However, LLCs, corporations, and other entities are not indestructible. If you do not carefully follow the rules for maintaining your business entity, a court may “pierce the corporate veil” in a potential lawsuit against the business, and you might still be held personally liable. In this article, we’ll go over some tips to avoid piercing the corporate veil. Ideally, you’ll be able to maintain the protective benefits of your business entity.
Why Use a Corporation or LLC?
Before we look into how to maintain the corporate veil, we should explain what the corporate veil does in the first place.
Business entities are useful for a number of things. For one, they make it easier to share ownership of a business via issuing shares or membership interests. They can also be useful for tax planning.
However, the biggest benefit of a business entity is limited liability.
Personal Liability Protection
Corporations and LLCs, and a number of other entities, protect business owners from personal liability in many cases.
The “Limited” in the name of many entities implies that it limits the owners’ personal liability.
For example, if a business within an LLC takes out debt and is suddenly unable to pay it due to financial hardship, the lender would not be able to recover from the business owner’s personal assets. This assumes that the business owner has not added a personal guaranty to the loan.
Similarly, if a business files for bankruptcy, that bankruptcy would be contained to the LLC, C-Corp, or other liability limiting entity. The business owners are not personally liable for the obligations of the business (again, barring something like a personal guaranty or similar exception).
This benefit encourages businesses to try to innovate and take entrepreneurial risks. Without this protection, business owners would be personally liable if their businesses failed, which would potentially stifle innovation and otherwise sensible risk taking.
But this protection is not absolute. The corporate “veil” that provides personal liability protection is not indestructible.
What Does it Mean to Pierce the Corporate Veil?
To “pierce the corporate veil” means that a court deems the business entity illegitimate and that the business owners should be held personally liable.
Rather than enjoy the protections of limited liability, the corporation, LLC, or other entity is treated as though it does not exist.
Needless to say, this is a serious decision for a court to make.
Thankfully, there are steps business owners can take to maintain the corporate veil to protect themselves from obligations that may arise from their businesses. Let’s go over those now.
How to Maintain the Corporate Veil
While no strategy is fool proof, following these guidelines should help to avoid piercing the corporate veil.
First, even though these entities offer tremendous protection for business owners, they do not limit liability for fraud and criminal offenses. Generally speaking, if a business owner commits fraud in his or her personal capacity, that person is liable for it. A business entity is not some convenient shield for any offense that a person wants to use it for.
That said, there are less nefarious ways that can cause a corporate veil to be pierced by a court. Here are some tips to avoid corporate veil piercing:
1. Follow State Corporation / LLC Requirements
Each state will have its own requirements for maintaining a business entity.
For example, a business will have to file an annual report or similar document every year with the state. A business owner needs to correctly file initial incorporation documents as well. Consult with an experienced attorney to make sure you are up to date with your entity filings.
Failure to follow state requirements may nullify an entity’s benefits. Make sure you carefully follow the guidelines set by your state.
2. Do Not Commingle Funds
A business should have its own bank account. And that business bank account should only be used for business purposes.
Commingling funds occurs when a person mixes his or her personal money with the business’s. This sends a signal to a court that the business is not legitimate and is merely an extension of the person.
Business funds should not be kept in someone’s personal account. Conversely, personal funds should not be kept in a business account.
Simply put, don’t commingle funds.
3. Treat Your Business Like a Business
In addition to never commingling funds, a business should be treated like a business.
That is, if the business isn’t really a business, and the entity is merely being used to protect someone from liability from creditors, a court may be more likely to pierce the corporate veil.
A business should ideally have its own contact information, some sort of branding or separate identity, and a clear business purpose. If a court can’t separate a business from someone’s personal activities, it won’t.
Maintaining clear business records will help. If a person can document the business’s activities, a court would be less likely to suspect that a person is abusing corporate protections for a non-business use.
In short, treating your business as its own entity will decrease the chances of veil piercing.
4. Don’t Undercapitalize Your Business
A business should have adequate capital and insurance when applicable.
A person who purposefully keeps minimal funds within a business might be suspected of abusing corporate protections. In other words, an intentionally empty business entity probably won’t be very helpful for protecting someone from personal liability.
Additionally, some states have restrictions requiring minimum insurance policies for certain businesses. Check with an attorney to make sure you are in compliance with minimum insurance laws.
5. Communicate Clearly with Your Customers and Others
If your business is a corporation or an LLC, your business communications and branding should reveal that fact. If your company name ends in “Inc.”, “Co.”, “LLC”, or similar, do not omit this from your branding. These letters communicate to the world that your company is a limited liability entity, so they are aware that your own personal assets are not in play if your company breaches a contract or causes injury. Failure to communicate this clearly could create an opportunity to pierce your veil.
Additionally, if you do business under a name that is different from the proper name for your entity, you should register that trade name with the State of Illinois. Failure to properly register a trade name can cause confusion and lead to veil-piercing.
Check with an attorney to make sure you are in compliance with Illinois laws regulating Corporations and LLCs.
Conclusion – Avoid Piercing the Corporate Veil
Business entities are some of the most powerful tools in the legal system, but only if your company follows the rules. If you find yourself in a dispute, the opposing attorney will surely try to pierce your veil to obtain leverage.
If you want to setup your business, or evaluate your current Corporate/LLC status, the experienced attorneys at Johnston Tomei Lenczycki & Goldberg LLC can help. Call us today at (847) 549-0600 or email us at email@example.com to schedule a free consultation.
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