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How to Avoid Piercing the Corporate Veil

Piercing the Corporate Veil

Limited liability entities (LLEs) are structured to separate owners from their business or to insert a “veil” between the two.  This corporate veil protects owners and company officers from being held personally liable for claims against the business.  LLEs can differ between states but generally include some, or all, of the following:

  • Limited Partnerships (LPs)
  • Limited Liability Partnerships (LLPs)
  • Limited Liability Companies (LLCs)
  • Corporations

If your business has been set up as an LLE, it may be tempting to think you’re safe from prosecution in your personal capacity.  However, the separation of personal and entity affairs must be demonstrable on an ongoing basis, that is, you must continuously act in ways that enforce the fact.

Piercing the Corporate Veil

Failure to do so could open you up to legal arguments that “pierce the corporate veil” by showing that you and your business are, in fact, the same person.  Failure to maintain the LLE, acts of bad faith, and injustice to third parties all represent opportunities to pierce the corporate veil.  They need to be guarded against, and attention should be paid to the following:

Fraud, wrongdoing or injustice to third parties

The courts are particularly motivated to pierce the corporate veil in instances where it appears that LLE structures have been used for nefarious purposes.  In making decisions that may be misconstrued, it is important to seek legal counsel to ensure transactions are legal and adequately arm’s length.

Inadequate capitalization of the LLE

If it can be shown that the LLE never had adequate funding to support itself as a stand-alone entity, owners will find it difficult to prove themselves separate from the business.  It can be worth getting expert advice on how to capitalize your business to avoid this.

Failure to follow formalities

Failure to follow the required formalities of your chosen LLE can make it appear like you are trading as a sole proprietor or partnership.  (Corporations have the most onerous formalities, but nothing stops other entities adopting those formalities that make sense and add value to their businesses.)  Examples of formalities to follow include:

  • Appointing registered agents
  • Registering all DBAs (“doing business as” names)
  • Filing all required annual returns
  • Holding, and minuting, required meetings and company decisions (corporations and LLCs)
  • Maintaining stock/members ledgers and any other organizational documents (corporations and LLC

Failure to identify the LLE

In any business-related dealings, third parties should be informed they are dealing with the entity. For example, any contracts with customers or providers should be in the name of the entity, and signatories should sign as representatives.

Failure to separate the individuals from the LLE

Personal transactions and finances should be kept entirely separate from the business.  Never pay personal expenses with company funds or vice versa.  Keep separate bank accounts and file separate tax returns.

The above list is not exhaustive but will be a good start to protecting your corporate veil.  Ensure that you are familiar with the specific requirements of the states you trade in and keep the concept of separation top of mind in your dealings.

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