What Is Piercing The Corporate Veil and How To Prevent It?

Table of Contents

1. What does piercing the corporate veil mean?

2. Corporations’ Responsibilities for Company Debts

3. What Happens When You Pierce the Corporate Veil

4. In what situations will courts pierce the corporate veil?

5. What Judges Look at When Piercing the Corporate Veil

What does piercing the corporate veil mean?

A limited liability company (LLC) or corporation is a legal structure that allows its owners and managers to shield themselves from individual responsibility for corporate obligations in the event that the firm goes bankrupt. Courts may, however, sometimes find shareholders, members, and owners of an LLC or corporation individually responsible for company obligations. This kind of accountability is known as “piercing the corporate veil.”

A lot of mom-and-pop stores are either closing their doors or frantically trying to stay afloat because of the current economic climate. Nobody wants to be responsible for paying off the obligations of a defunct corporation or limited liability company (LLC) if they operate a small business. When money is tight, owners may be personally responsible for their company’s obligations if a creditor sues for payment and the court decides to “pierce the corporate veil” (lift the veil of limited responsibility) and find the owners in default. Please contact our corporate litigation attorney concerning corporate compliance.

Corporations’ Responsibilities for Company Debts

Legally, the persons who form and own a corporation or limited liability company (LLC) (the “shareholders” or “members”) are not the same as the company or LLC itself. As a distinct legal entity from its owners and managers, owners and managers of corporations and limited liability companies (LLCs) enjoy reduced personal responsibility for business obligations, which is a major perk of adopting one of these business structures. As a general rule, the owners and managers of a corporation or limited liability company (LLC) are not personally liable for the obligations of the firm.

In some cases, however, courts may disregard an LLC’s or corporation’s limited liability status and impose individual responsibility on its members, directors, stockholders, and officers. “Piercing the corporate veil” describes this type of situation. The veils of small limited liability companies (LLCs) and closely held corporations (often shortened to “close corporations”) are the most vulnerable to piercing.

What Happens When You Pierce the Corporate Veil

Members, owners, or shareholders of an LLC or corporation can have their personal wealth drained from the business if a court decides to “pierce the corporate veil” and see the company’s financial records. Creditors may seize the owners’ personal residence, savings, investments, and other possessions to settle the business debt.

However, courts will not hold innocent persons personally accountable for corporate debts; only those responsible for the fraudulent or wrongful acts of the corporation or LLC would face personal accountability.

In what situations will courts pierce the corporate veil?

If there are certain conditions met, the courts may be able to hold members, shareholders, executives, and directors individually liable for business debts and other obligations.

The proprietors and the company are practically one and the same: A court may conclude that an LLC or corporation is nothing more than the owners’ “alter ego” and that they are handling business matters directly, without the need for a formal legal separation, if the owners do not keep their personal and business finances separate.

If a business owner uses the company’s money for personal expenses or doesn’t follow the rules that an LLC or corporation must follow (like not recording important decisions in meeting minutes), a court could rule that the owner doesn’t have the limited liability that would normally come with a corporate business structure.

The business committed wrongdoing or fraud: A court could rule that limited liability protection does not apply if the owner(s) acted dishonestly or recklessly and lost money through reckless borrowing or entered commercial arrangements knowing the company couldn’t pay the bills.

The expense to the company’s creditors was unfair: A court will attempt to rectify this injustice by penetrating the veil if any of the following apply: the debtor is left with unpaid invoices or an unpaid court judgment; and the company has not paid its debts or judgment.

What Judges Look at When Piercing the Corporate Veil

Courts typically look at the following when deciding whether to pierce a corporation’s veil:

Whether or not the LLC or business committed fraud
If the LLC or corporation does not adhere to the required corporate procedures
The lack of sufficient capitalization of the corporation or LLC (a corporation that could never function due to a lack of funding would not be considered an independent entity)
When a single individual or a small group of persons with close ties controlled the whole company or limited liability company.
Due to their size and operations, certain businesses and LLCs are particularly susceptible to these variables. Loss of limited liability status is more likely to occur in closely held businesses than in huge, publicly listed organizations. This is due to a number of factors.

Challenging established organizational protocols: Due to a lack of adherence to corporate procedures, small firms are more susceptible to having their corporate veil penetrated than larger corporations. If you want to stay out of danger, it’s wise to be cautious. All limited liability companies (LLCs) and small businesses must follow the regulations for forming and maintaining corporations, which include:

Hosting yearly gatherings of board members and stockholders
Maintaining precise and comprehensive notes (referred to as “minutes”) of significant decisions reached during the meetings
Establishing the rules for the business
Making sure that the officers and workers follow the rules.

Mixing assets: In contrast to owners of bigger companies, those running smaller businesses may be more inclined to pool their own resources with the company’s or LLC’s. For instance, it’s not uncommon for small business owners to use company funds for personal expenses, such as paying off a mortgage or buying a car.

This practice is known as “diverting assets” from the company account. This is known as “commingling of assets.” To stay out of legal hot water, businesses should have separate bank accounts, and owners should never utilize company funds for personal expenses or deposit corporate checks into their own accounts.

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What Is Piercing The Corporate Veil and How To Avoid It?