Piercing the Corporate Veil: Everything You Need to Know
Piercing the corporate veil occurs when the courts ignore the limited liability placed on a company thereby exposing those affiliated to be liable.6 min read
2. Why is the Ability to Pierce the Corporate Veil Important?
3. What Happens if the Veil is Pierced?
4. Reasons to Consider Piercing the Corporate Veil
5. Reasons You Shouldn't Pierce the Corporate Veil
6. Common Mistakes Businesses Make that Expose Them to Liability
7. Piercing the Corporate Veil FAQ
8. Examples of Piercing the Corporate Veil
9. Steps to Avoid Liability
10. Learn More From an Experienced Attorney
What Does It Mean to Pierce the Corporate Veil?
Piercing the corporate veil is when the courts ignore the "corporate veil" placed on an LLC or corporation. A corporate veil is when a business is incorporated so that its owners, shareholders, and employees will not be held personally responsible if the business can't pay its debts. A corporate veil is also known as limited liability.
LLCs and corporations are legally separate from their owners and shareholders — this is what allows the veil to work.
Why is the Ability to Pierce the Corporate Veil Important?
Piercing the veil can help protect smaller businesses from larger ones. For example, if a large business refuses to pay a smaller one for provided services.
Also, it can be used to force corporations to comply with government programs. However, courts are reluctant to pierce the veil. Three major grounds for these cases include:
To make a corporation comply with programs like Social Security
Manipulating bankruptcy laws
Fraud has been committed
Most veil cases are based on these three issues. Find out if these issues are in play before trying to pierce the corporate veil.
What Happens if the Veil is Pierced?
When the corporate veil is pierced by a court, those involved with the corporation may be held liable for its wrongdoing. This can include members of the corporation or LLC, its shareholders, and its owners. The personal finances of these people may be seized in order to pay corporate debts. Creditors may pursue houses, personal bank accounts and investments, and any other assets of value.
However, when the veil is pierced, the court will only hold people liable who are proved to be responsible for the corporation's wrongful action. Anyone innocent of misdeeds will not be responsible for the corporate debt.
Reasons to Consider Piercing the Corporate Veil
There are some reasons you might need to pierce the veil:
A business may have committed fraud. Fraud is the top reason to pierce the veil. For example, if a business shuts down to avoid paying debts, this is fraud. Piercing the veil may be the only way to get your money after fraud has happened.
Corporations must maintain their different identities. This means they need to have their own finances, owners, and buildings. If they don't, they have not separated properly. The veil may need to be pierced in this circumstance.
Companies must also be separate from their shareholders and owners. This is slightly different than companies being separate. For instance, if an owner is using business money like personal money, they have not separated from their company.
If business does not maintain enough capital, the veil may need to be pierced. A lack of money prevents a business from paying their lenders. It may also keep it from paying employees. Intentionally low capital is a main reason to pierce the veil.
Corporate formality should be followed. This includes annual meetings, keeping full records, and adopting bylaws. Corporations that don't follow these rules may have their veil pierced. Lack of formality is a red flag to courts.
Piercing the veil is not necessarily punishment. It can even be a tool to encourage businesses to run properly. A pierced veil can encourage investment and smoother functioning. There are very good reasons to pierce the corporate veil.
Reasons You Shouldn't Pierce the Corporate Veil
Sometimes, piercing the veil is not the right decision. Courts don't like to do it because it signals a sham company. This can hurt the economy and consumer trust. Several alternatives have been proposed to limit the practice.
Required insurance would lower the risk of veil piercing. Voluntary insurance has been proposed for the same reason. If all shareholders held some liability, this could also eliminate the need to pierce the veil. Finally, mandating a minimum capital level should prevent piercing the corporate veil.
Adopting these practices can limit veil piercing. This strengthens both companies and the economy.
Common Mistakes Businesses Make that Expose Them to Liability
Businesses should work to maintain their veil. This depends on avoiding common mistakes. Being aware of these risks can help you avoid them. Avoid liability by:
Not Asset Mixing: A corporation is a legal person. This means it has its own assets. Never mix personal and business assets. Doing so may lead to your veil being pierced.
Presentation: Always present your business as a business. Design appropriate signage. Print business cards solely for the business. Think about a logo. These all signal a properly run business. It also shows separation from the owner.
Records: Clear records will maintain your veil. This is especially true for financial records. Missing or unclear records are a warning sign to Courts. They can indicate asset mixing or other bad actions. Be vigilant about record keeping.
Formalities: As mentioned, corporate formality is important. Following this rules shows you are doing things the right way. Hold annual meetings. Follow your adopted bylaws. Do everything possible to follow corporate formality.
Lack of Capital: Voluntarily maintain a minimum capital level. This shows you care about paying your creditors. Although not illegal, low capital can put your veil at risk.
Pay Shareholders: Courts will pierce your veil if you don't pay your shareholders. This should always be a priority. Not regularly paying shareholders is a big mistake to avoid.
Piercing the Corporate Veil FAQ
What is the Alter-Ego Theory of Liability?
Alter-Ego Theory is used for fraudulent corporations. Corporation cannot be used for personal business. If it is, it is the alter-ego of its owners and shareholders. This opens them to liability. An example of this is a parent company fully controlling its subsidiary. Businesses should be separate from their owners and shareholders. Alter-ego theory can be used to pierce the veil. This also applies to LLCs.
How Can I Protect My Assets?
Fortunately, protecting your assets is easy. All you have to do is follow rules for maintain a corporation. Maintain corporate or LLC formality. Avoid low capital levels. Document business actions and finances. Keep personal and corporate assets separate. Make your corporate or LLC status clear. These best practices will protect your assets and maintain your corporate veil.
Examples of Piercing the Corporate Veil
Edwards Company, Inc. v. Monogram Industries, Inc: In this case, Edwards sued Monogram for debt owed by their subsidiary company, Monitronics. Edwards claimed Monitronics only existed on paper and that their debt belonged to Monogram. They sought to pierce the corporate veil. It was denied because the court could find no fraud and it could not be proven that Monogram and Monitronics were the same company.
Doberstein v. G-P Industries, Inc: This case is interesting for how it was decided. G-P Industries was hired to remodel a home. They could not finish the job because of financial losses. Doberstein sued them for their failure to complete the project. Fraud is the main charge in this case. Although G-P may have acted unscrupulously, no fraud was found, so they won the case.
Steps to Avoid Liability
The main reason for a corporation or an LLC is to avoid personal liability. However, even with your veil in place, liability is still a possibility. Here is a checklist to help you avoid liability:
Sign documents and contracts with your business title.
Personal and business assets should never mix. Don't pay corporate expenses with personal money. Also, don't use corporate money for your own benefit.
Hold annual meetings — this includes shareholder meetings. Regularly meet with your board of directors.
Maintain a company record book. Include meeting minutes. Also, fully detail financial transactions.
File annual reports with the Secretary of State and do so in a timely manner.
Always know where your founding documents are. These can include incorporation articles and bylaws. You should also maintain an ownership ledger.
Register every name you use for your business. Submit registration to the Secretary of State and county recorders.
Register your business in every state where you operate.
Understand the rules for operating everywhere you do business.
Finally, make sure to hire an attorney. An experienced attorney can help you avoid liability. They can also give you tips for protecting your corporate veil.
Learn More From an Experienced Attorney
Maintaining or piercing the corporate veil is easier when you have legal help, which is why you need an UpCounsel attorney. If you're thinking about incorporating or forming an LLC, we can help with the process. If you are seeking to pierce the corporate veil, we can examine your case and let you know if piercing the veil is possible.
On the UpCounsel marketplace, you'll find countless, knowledgeable attorneys ready to help with your case. You'll also be able to get great pricing rates and will be able to find a great attorney from the comfort of your own home. Contact UpCounsel today to learn how you can get the legal help you need.