Key Takeaways

  • The corporate veil protects LLC owners from personal liability for business debts and obligations.
  • Simply forming an LLC is not enough to ensure protection; owners must actively maintain the separation between personal and business affairs.
  • Adequate capitalization, proper documentation, and observing corporate formalities are essential to keeping the veil intact.
  • Personal use of business funds or fraudulent conduct may lead to veil piercing, exposing owners to personal liability.
  • Adding layers like proper contracts, compliance with state laws, and avoiding personal guarantees strengthens the corporate veil.

Piercing an LLC corporate veil is a term used when a creditor is able to sue the business owners of an LLC. In general, business owners enjoy the protection of their personal assets from business liabilities due to their forming of the LLC. This protection that LLC owners enjoy from their corporate entity is referred to as a corporate veil.

It is important to note that simply forming an LLC does not automatically protect you from all personal liability in the business. There are some situations where a creditor has been able to pierce the corporate veil including:

  • The company is considered severely undercapitalized.
  • The owners of the company have not kept their personal and business affairs and accounts separate.
  • The actions that the company engaged in were deemed wrongful or fraudulent.

How Can You Maintain Your Corporate Veil?

There are ways for business owners to ensure that their personal assets are protected from business debts. To help keep your corporate veil intact you will need to:

Start-Up Your Business With Adequate Capital

If you start your business without enough capital to be able to cover your expected liabilities, your creditors could argue that you should not be given the protection of a corporate veil since there was not sufficient separation from the owners.

To avoid this complication, you will want to make sure that you make a substantial initial investment in the business to be able to dispute this claim. Even though money can be tight when starting up a business, you will need to make a judgment call on how much money you will need to cover your initial start-up costs and liability. This includes making sure that you have enough to pay your creditors and other third parties you will owe money to.

Being solvent, in the beginning, will help reduce your risk of veil piercing. To provide money to start your operations and purchase any necessary equipment you can:

  • Fund it with your own money
  • Accept money from other people and give them a portion of the business
  • Acquire a business loan

Keep Financial Affairs Separate

It is vital to keep your business financial accounts separate from your personal accounts. Open a business bank account and apply for a credit card in the name of your business for expenses. If you need to use money from your business account, make sure that you officially pull it as a recorded draw instead of simply paying your personal bills from the account.When the owner wants to add additional funds to the business you need to make sure to document it as a capital contribution to the company and provide the appropriate documentation when the transaction occurs. Make sure to maintain a book of accounts in which you document all of your business expenses. There are many good small business accounting programs.

Sign All Documents Correctly

When completing any dealings for the business, you will want to make sure that you sign for it in the name of your company. You should sign your name along with the name of the company for clarification. For example, sign all documents and paperwork, John Doe, Authorized Member of 123 LLC. This will reflect that the signer is authorized to sign on behalf of the company and the company is also the responsible party. This will help you establish a separation between your personal affairs and your business.

Document All Company Business

You should always follow the guidelines for meetings that have been established under your LLC's operating agreement. You will need to document your minutes formally and maintain professional records. Any decisions that the company makes should be formally recorded and signed by all the members as well. Maintaining business formalities is vital to creating a separation between the business entity and the owners and keeping your LLC corporate veil intact.

In effect, this paper trail will help prove that your business operated as its own entity and was not simply created as a form of liability protection for its owners. You should maintain all of this business documentation for at least seven years.

Understand the Legal Factors Courts Consider

Courts may consider several factors when determining whether to pierce the corporate veil and hold LLC members personally liable. Understanding these factors helps LLC owners take the necessary steps to maintain their liability protection. Common factors include:

  • Commingling of Funds: Using business accounts for personal expenses or vice versa.
  • Failure to Follow Formalities: Not adhering to operating agreement provisions or failing to document significant business decisions.
  • Undercapitalization: Starting the business without sufficient funds to cover foreseeable debts and obligations.
  • Fraudulent or Wrongful Conduct: Using the LLC to perpetuate fraud or illegal activities.
  • Misrepresentation: Falsely representing the business structure or misusing the corporate form to avoid obligations.

By addressing these areas proactively, LLC owners can significantly reduce the risk of veil piercing.

Avoid Personal Guarantees Where Possible

A personal guarantee is a commitment by an LLC member to be personally liable for a business debt if the LLC cannot pay. While sometimes necessary, offering personal guarantees can undermine the protection of the corporate veil. To help maintain the veil:

  • Limit the use of personal guarantees to only essential situations.
  • Negotiate contracts to rely on the LLC's creditworthiness, not personal credit.
  • Clearly document all guarantees when they are required, distinguishing personal liability from company obligations.

Minimizing personal guarantees helps reinforce the LLC's status as a separate legal entity.

Comply With All State and Federal Requirements

Consistent compliance with legal obligations is another key component in how to establish a corporate veil effectively. This includes:

  • Filing annual reports and paying required state fees.
  • Maintaining any necessary business licenses and permits.
  • Keeping accurate and up-to-date records as required by state law.
  • Following industry-specific regulations, if applicable.

Failure to comply with these requirements can suggest to courts that the business entity is not being treated as separate and distinct from its owners.

Draft Strong Operating Agreements and Contracts

A well-drafted LLC operating agreement not only helps manage the internal affairs of the company but also supports the corporate veil by:

  • Clearly defining member roles and responsibilities.
  • Outlining procedures for decision-making and dispute resolution.
  • Specifying processes for capital contributions and distributions.

Additionally, use clear and professional contracts when engaging with third parties. Contracts should always specify the LLC as the responsible party, and all agreements should be signed on behalf of the LLC, not in an individual capacity.

Frequently Asked Questions

  1. What does it mean to pierce the corporate veil?
    Piercing the corporate veil means holding LLC members personally liable for the company's debts or obligations, typically due to misuse of the LLC structure or failure to maintain proper separation between business and personal affairs.
  2. How can I prevent my LLC’s corporate veil from being pierced?
    Maintain proper documentation, keep financial affairs separate, adequately capitalize the business, comply with state requirements, and avoid fraud or wrongful conduct.
  3. Does having an operating agreement help maintain the corporate veil?
    Yes, a comprehensive operating agreement supports the legitimacy of your LLC and outlines important internal processes, which helps demonstrate the separation between the business and its owners.
  4. Can personal guarantees jeopardize my corporate veil protection?
    Offering personal guarantees may expose you to personal liability even if your LLC otherwise maintains the corporate veil. Use them cautiously and only when absolutely necessary.
  5. Do I need a lawyer to help establish and maintain my corporate veil?
    While not legally required, consulting an attorney can help ensure you meet all legal requirements and avoid mistakes that could risk piercing the corporate veil. You can find experienced business attorneys on UpCounsel to assist with these matters.

If you need help with understanding how to establish a corporate veil, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.