You’ve likely heard about veils in the context of a wedding, where the bride will sometimes wear a veil over her face. So what, then, is a corporate veil? By definition, a veil’s purpose is to cover something. In the same way that a bridal veil shields the bride’s features from sight, a corporate veil shields a business owner’s personal assets from lawsuits.
This corporate veil refers to a company’s limited liability protection, which prevents creditors from pursuing an LLC member’s personal assets if the company is sued. However, there are some situations where a corporate veil can be “pierced,” which removes this personal asset protection. How can this happen, and how do you avoid it?
If your company has limited liability protection or you’re considering forming an LLC, keeping your corporate veil intact should be a high priority. So, it’s important to familiarize yourself with the actions and circumstances that could pierce it, then avoid them at all costs. We’ve outlined all of them here in one place for you and by the time you’re done reading, you’ll be confident in your corporate veil’s strength and longevity.
Quick Note: If you haven’t yet created an LLC and would like help, ZenBusiness and LegalZoom are both very popular services that can take care of the paperwork for you.
What Is a Corporate Veil?
The corporate veil is one of the most important aspects of an LLC – one of the things that makes it a popular business structure – because it provides the member/owners with limited liability protection.
Let’s take a step back and discuss limited liability. What, exactly, is it limited to? This term describes an LLC member’s personal assets – their savings, house, car, collection of vintage comic books, etc. If your company is sued, these possessions will be sheltered from creditors, who will only be allowed to pursue business-related assets.
This protection, however, isn’t impenetrable. In certain cases, your corporate veil can be “pierced,” and your personal possessions will be fair game to creditors. But if you know what conditions can cause this piercing, you can deftly avoid them and maintain your protections.
Why Would a Court Allow Your Corporate Veil to Be Pierced?
It should provide some solace that a court won’t pierce your corporate veil at the drop of a hat. In fact, it’s quite difficult to do so, not something you can often stumble into. No court system in America takes piercing the corporate veil lightly, which is why there’s a very specific set of circumstances that must occur before they’ll even consider it.
Still, because the consequences of losing your limited liability protection are so dire, you should try to avoid it at all costs. Here are the three conditions that must be met for a court to pierce your corporate veil.
Your LLC Is Not a Separate Entity From Its Owners as Individuals
First off, the court would need to determine that your business is not actually distinct from you (or your co-owners), that it’s simply an extension of the individual(s). This is more common with single-member LLCs than with multi-member LLCs ― largely because it’s an easier mistake for an individual than a group ― but it can happen to any LLC.
How? Let’s say you start paying personal bills, like mortgages or car payments, using a business bank account or credit card. This would indicate that you and the company are one and the same. Or, maybe you never properly established the business as a legal entity in the first place, which is also a common tip-off.
A Member Uses the LLC to Commit Fraud
The second step involves wrongful actions committed by an LLC owner. For example, your company may have borrowed heavily and has no chance to pay back the money, or it’s simply losing money beyond its means to recoup. Even if they’re not intentionally malicious, any acts that show the court that an LLC’s ownership doesn’t care whether they can pay their invoices will endanger the company’s corporate veil.
Creditors Are Damaged Unfairly by the LLC
Does someone your LLC conducted business with now have bills or court settlements that they can’t pay as a result of your company’s actions? This is the third aspect of piercing a corporate veil. If your LLC becomes insolvent or goes out of business, don’t expect the corporate veil to protect you from your creditors.
How Can I Avoid the Piercing of My Corporate Veil?
Remember the steps listed above! Write them down or bookmark this page so you don’t forget them as your business progresses. But we’re not just going to say “don’t do these things,” and leave you there. We want to set you up for sustained success, not simply basic compliance. Here are some practical steps you can take to keep your corporate veil unpierced.
Follow the Law When Forming Your LLC
Don’t just fling yourself carelessly into the LLC formation process. Do your homework, learn the ins and outs of your state’s unique rules and processes. Then follow them when forming your LLC and it will go a long way toward maintaining your corporate veil. Many cases where courts decide to pierce the corporate veil are a direct result of the LLC not being properly formed. Basically: complete and file your Articles of Organization carefully. Make sure all the relevant information is included, follow the proper filing procedures, and definitely don’t knowingly break any rules.
Stay Current on All Maintenance Requirements
Your LLC maintenance doesn’t end with the Articles of Organization. Most states have ongoing compliance and reporting requirements too. It should go without saying that you should do your best to keep up with these compliance requirements, but far too often we hear of corporate veils being pierced because of a missed annual report or maintenance fee. Don’t let that happen to you!
Keep Your Personal and Business Assets Separate
How can you expect personal asset protection if you never make a distinction between your personal and business assets to begin with? Practically speaking, don’t use your business bank account or credit card to pay personal bills, and don’t use your personal bank account or credit card to pay bills for your business. This just intertwines your finances and indicates to courts that it’s all the same.
You should also make sure to properly document any situation in which you contribute funds to your LLC. Your records need to reflect that it was not a case of money transferral between personal financial interests, but rather an instance of contributing to the LLC. Keeping diligent records means you have proof if your finances are ever questioned. Pro tip: accounting software can be a huge help here!
Maintain a Detailed Paper Trail for Your Business
When it comes to keeping your personal assets separate, keeping detailed records is vital. Think of it this way: do you document every detail of your own personal life? No one actually does this, so writing down every detail of your LLC’s business life cycle is a great way to indicate its separation from you as an individual. Plus, this provides benefits beyond the corporate veil too, like accurate accounting or settling disputes.
Sign on Behalf of Your Company, Not as Yourself
As an LLC member/owner, you’ve probably signed so many documents that your signature is perfect, you could do it in your sleep. But you shouldn’t go into autopilot, sign a document, and leave it at that. Make sure you include your company name with your signature, otherwise it could appear that you’re signing the document as an individual rather than on behalf of your company. If you fail to clearly identify that your signature is representative of your LLC, it’s more likely that a court will deem that your business is not sufficiently separate from you as a person.
Adequately Fund Your LLC From the Beginning
If your LLC isn’t adequately capitalized during the startup phase or at any other point in its history, it could be grounds to pierce the corporate veil. Your company needs to be believably sustainable. Otherwise, a court might anticipate it causing unfair damage to creditors by an inability to pay debts. Failing to adequately fund your LLC gives your creditors a big leg up when arguing that your business was never separate from you as an owner.
What Types of Liability Does the Corporate Veil NOT Cover?
The corporate veil is powerful, but it’s not all-powerful. It won’t protect you in every conceivable situation. Creditors can find ways around it, even it the veil hasn’t been pierced.
In an LLC’s standard tax structure, business profits pass through the company and are instead claimed on members’ personal tax returns. This means that the corporate veil cannot protect you from tax obligations. Don’t let your taxes slide into delinquency, because creditors (in this case, the IRS) will be able to pursue your personal assets.
Reckless Personal Acts
“Don’t be reckless” is a good life mantra in general, but especially when it comes to your business. If you commit a careless personal act while pursuing company business, you shouldn’t expect the corporate veil to protect you. For example, if you’re making a delivery for your business and you cause a traffic accident, the corporate veil won’t swoop in to save the day. Acting recklessly could cause a court to hold you personally liable for any damages.
In certain situations, you as the business owner will be asked to personally guarantee a contract on behalf of your LLC, like entering into a costly commercial lease or taking out a sizeable business loan. In these situations, you are waiving your right to personal asset protection with that particular creditor. If your business doesn’t have many assets, personal guarantees might be unavoidable, but be very cautious when making them.
Why Is the Corporate Veil Harder for Single-Member LLCs to Maintain?
If you’re the only employee in your LLC, a versatile, do-it-all owner, you might find it more difficult to keep your business and personal lives separate. A multi-member LLC can spread its responsibilities out among several owners, but if you’re doing it on your own, the financial responsibility rests solely on your shoulders. Consequently, it’s more difficult for single-member LLCs (SMLLCs) to maintain their corporate veil. Here’s why:
Commingling Business and Personal Assets
This is an all-too-easy mistake for single-member LLCs to make. When you’re running a business by yourself, it might seem like an unnecessary hassle to keep your business and personal assets separated, when in reality it’s just as crucial as it is for a multi-member LLC. Commingling your assets as the owner of an SMLLC is extremely dangerous and not advisable under any circumstances. Doing so can cause a court to view you and your business as one entity.
Keeping Up with Formalities
To prove your LLC’s existence as an independent entity, keep adequate records and stringently following compliance guidelines. This might seem excessive when you’re running a business by yourself, but it’s absolutely crucial. Keep in mind that you’re not necessarily doing these things for your own convenience, but rather to ensure that your corporate veil remains intact.
The limited liability company is a relatively recent development in the American business landscape and, as such, there isn’t much precedent for how court systems should treat it. On top of that, many of the existing laws and court decisions regarding LLCs were originally created for corporations, then adapted to fit the multi-member LLC format, leaving single-member LLCs in an uncomfortable grey area.
Maintaining the corporate veil is not only a highly important part of running a limited liability company, but it can also be quite complicated and especially important if you run a single-member LLC. At first, it might seem excessive and unnecessary, but if you ever need a stark reminder, just review the potential consequences.
Bookmark this page and check back every few months to remind yourself of the ways you can protect your corporate veil. It’s never a bad idea to make sure you’re doing everything you can to maintain your limited liability protection. Think of it as continuing maintenance for your house, car, savings, and other assets.
Follow this guide and you can sleep easy at night, knowing that your business is safely covered by the corporate veil for now and the foreseeable future.