What Is a Corporate Veil? (How to Protect Yourself)
If you’re a member of a limited liability company, or if you’re considering starting an LLC of your own, it’s likely that you’ve heard the term “corporate veil.” The corporate veil refers to a company’s limited liability protection, which prevents creditors from pursuing an LLC member’s personal assets in the case of a lawsuit. 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?
In this guide to the corporate veil, we’ll discuss how the corporate veil protects you, the factors that go into a court’s decision to pierce the corporate veil, and how you can protect yourself from losing your limited liability protections. By the time you’re done reading, we’re confident that you’ll understand how to avoid this potentially disastrous occurrence for your LLC.
What Is a Corporate Veil?
The corporate veil is one of the most important aspects of a limited liability company, because it affords LLC member/owners with the limited liability protection at the heart of any LLC. If your company is sued, the corporate veil protects your personal assets, and the only assets your creditors can pursue are limited to the investments you’ve made into your LLC.
When the corporate veil is intact, your house, cars, belongings, and personal bank accounts are protected from creditors. However, if your corporate veil is pierced, creditors are free to come after any of your assets that they desire ― whether they’re business or personal assets no longer matters. Let’s discuss how this can happen, and how you can prevent it.
Why Would a Court Allow Your Corporate Veil to Be Pierced?
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 for any court to even consider it. Still, because the consequences of losing your limited liability protection are so dire, it’s absolutely advisable that you do everything you can to avoid this happening. Let’s discuss the three conditions that must all 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 distinct from you (or your co-owners) as a person. While this is more common with single-member LLCs than with multi-member LLCs ― largely because it’s an easier mistake for an individual to make than it is for a group ― it can happen to any LLC.
So how does this happen? The most common way for a court to determine that an LLC isn’t distinct from its owner is if an LLC member pays personal bills, like their mortgage or a car payment, using their business credit card or the company’s bank accounts. Another way this can happen is if the court decides an LLC member never took the proper formal steps to correctly establish the business as a separate legal entity to begin with.
A Member Uses the LLC to Commit Fraud
The second step involves wrongful actions committed by an owner of the LLC. If you’ve borrowed heavily to the point where your company has no chance to pay back the money, or if your business is simply losing money beyond its means to recoup, the court can decide to continue pursuing piercing your corporate veil. Basically, 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?
If you want to avoid the issues detailed above, there are some ways you can protect your LLC’s corporate veil. As long as you follow the rules and regulations regarding LLC ownership, you can rest easy knowing that your limited liability protection is intact.
Follow the Law When Forming Your LLC
Simply put, forming your LLC correctly according to all relevant rules and regulations set forth by your state goes 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 to begin with. In short, take care when writing your articles of organization. Make sure all the relevant information is included, and definitely don’t knowingly break any rules.
Stay Current on All Maintenance Requirements
Most states require LLCs to submit annual reports, which usually have ongoing maintenance fees associated with them. 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 the corporate veil being pierced because of a missed annual report or maintenance fee. Don’t be that person!
Keep Your Personal and Business Assets Separate
How can you expect to have personal asset protection if you never make it clear that there’s a distinction between your personal and business assets to begin with? In short, you should never use your business bank account or credit card to pay personal bills, and you should never use your personal bank account or credit card to pay bills for your business.
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 you transferring money between your own personal financial interests, but rather an instance of you making a contribution to the LLC. Accounting software can be a huge help in this regard!
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 yourself as an individual. There are some other benefits to this beyond the corporate veil as well, like for accounting purposes, or for settling disputes.
Sign on Behalf of Your Company, Not as Yourself
As an LLC member/owner, you probably have to sign quite a few documents. When you do so, make certain to include your company name along with your own 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
Another issue might arise if your limited liability company isn’t adequately capitalized beginning in the startup phase. If there’s any moment in your company’s history when it didn’t have enough money to be believably sustainable, your LLC can easily be disqualified from corporate veil protection. 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?
While the corporate veil does protect your personal liability in many ways, there are limits to its power. There are a few ways creditors can pursue your personal assets, even if your corporate veil is not pierced by the courts.
Due to the pass-through method of taxation used by most LLCs, business profits are passed through the company, and are claimed by the LLC members on their personal tax returns. As such, the corporate veil does not protect you from tax obligations. If you become delinquent on your taxes, your creditors (in this case, the IRS) can pursue your personal assets.
Reckless Personal Acts
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 exactly swoop in to save the day. This is just one example of a personal act that could result in your creditors successfully pursuing your personal assets.
There are times as a business owner when you’re asked to personally guarantee a contract on behalf of your LLC, for example if you’re entering into a costly commercial lease, or if you’re taking out a sizeable business loan. In these situations, you are waiving your right to personal asset protection with that creditor. If your business doesn’t have many assets, personal guarantees can sometimes be unavoidable, but you should be very cautious when making them.
Why Is the Corporate Veil Harder for Single-Member LLCs to Maintain?
We’ve already noted a couple of the ways that the corporate veil of a single-member LLC is easier to pierce than that of a multi-member LLC, but we figured it was probably worth the time to build out this idea into a full section of its own. Maintaining LLC members’ personal asset protection is easier for an MMLLC than an SMLLC for the following reasons.
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 never advisable under any circumstances.
Keeping Up with Formalities
Continuing the line of thought from the previous point, keeping adequate records and stringently following compliance guidelines for LLCs can feel excessive when you’re running a business by yourself. However, it’s good to 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 in general is a relatively recent development in the American business landscape, and as such, there isn’t much precedent for the way court systems should treat this business type. It’s even trickier for SMLLCs, because many of the laws and court decisions that do exist 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.
As you can see, maintaining the corporate veil is not only a highly important part of running a limited liability company, but it can also be quite complicated. Especially for single-member LLC owners who can sometimes see the compliance requirements as an unnecessary hassle, it’s vital to keep in mind what can happen if you don’t follow the regulations to the letter.
In general, we recommend bookmarking this page and checking 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.
Thanks for reading, and we wish you the best of luck in maintaining your corporate veil!