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Business Owners Sometimes Can Personally Be Liable
May 2, 2012
For many business owners, incorporating or organizing a business is attractive because it ensures that personal assets, such as a home or investments, are separate from the business and cannot be taken to make up for business losses. In most cases this is true and serves to protect the shareholders and members of a business from being personally liable for the acts of the corporation or company.
“Piercing the corporate veil” refers to the ability to hold a corporation’s shareholders or limited liability company's members personally liable for losses sustained by the corporation or company in certain circumstances and arises when the assets owned by the business are insufficient to satisfy a judgment against it.
Several factors are considered by the courts in determining whether to pierce the corporate veil:
- Did the business commit fraud? Fraud in this instance would include the shareholder(s) or member(s) recklessly borrowing and losing corporate/company funds, making business deals knowing the corporation/company can't pay the invoices, or in any way acting recklessly or dishonestly. The bigger the fraud, the more likely the veil will be pierced. In fact, sometimes fraud alone will warrant piercing the corporate veil.
- Did/does the business follow corporate formalities? It’s important that a business acts like the corporation or company that it is. The shareholders or members should maintain an actual and formal legal separation between their business and their personal affairs, including bank accounts. If a business fails to hold board meetings, vote on major issues, or keep corporate minutes and if no separation ultimately exists, a court could find that the corporation/company is really just the shareholders’ or members’ alter ego. In such a situation, the corporate veil may be pierced.
- Does the business owner mix corporate/company and personal funds? If a business owner uses her business assets to pay personal expenses, the veil also may be pierced. Judges reason that if a business owner feels that she can use corporate money to pay for personal expenses, then she also should be able to use her own money to pay for the company’s debts.
- Was the corporation/company grossly undercapitalized? If the capital in the business was or is unreasonable given its possible liabilities, then it is more likely that the veil will be pierced. However, courts will take insurance into account; if a start-up entity that is established on debt has $100,000 of liability insurance, the court generally will view this as $100,000 available to tort creditors and most likely will decide this factor in favor of leaving the corporate veil intact.
- Did the corporation's/company's creditors suffer an unjust expense? If a party that did business with the corporation/company is left with unpaid bills or an unpaid court judgment against the corporation/company and the above factors are present, a court may try to correct this unfairness by piercing the corporate veil.
A business owner can ensure that her corporation or company maintains its limited liability by following corporate formalities, acting in the best interests of the corporation or company, fully disclosing conflicts, playing fairly and by the rules, and keeping corporate funds separate from personal funds.