One of the main benefits of choosing a corporation or LLC as your business structure is that it provides you with limited liability.

Piercing the Corporate Veil – What it Means and How You Can Protect Yourself

One of the main benefits of choosing a corporation or LLC as your business structure is that it provides you with limited liability.

This means you generally won’t be held personally liable for matters involving your business – creditors can’t go after personal assets like your house or bank account. But there are exceptions to this rule. You may have heard the term, “piercing the corporate veil.” When the corporate or LLC veil is pierced, a company’s directors, owners, members, and shareholders are held personally liable for its actions or debts. Courts generally only pierce the corporate veil in cases of serious misconduct.

According to Nolo, courts will only hold liable individuals responsible for the business’s wrongful actions; innocent parties are safe. It lists three situations in which the veil might be pierced:

There’s no separation between the business and its owners: Owners of corporations and LLCs are supposed to keep their personal finances separate from those of their businesses. An example of a business owner failing to do this would be paying their personal bills with money from their business checking account. In lawyer speak, this is referred to as commingling of funds. When this happens, a court can say that the business owner operates their business as if the LLC or corporate structure doesn’t exist, so they’re not entitled to limited liability.

The company did something financially reckless or fraudulent: If a company does something financially reckless, such as recklessly borrowing and losing money, or something fraudulent, such as making a business deal when the business couldn’t pay what it promised to pay, a court could find that limited liability doesn’t apply.

The company’s creditors were left with an unjust cost: A court may decide to pierce a company’s veil if it is undercapitalized, burdening its creditors with unpaid bills or unpaid court judgements and factors from items 1 and 2 are present.

The businesses most likely to get pierced

Closely held companies are especially likely to get pierced. In the words of the IRS, a closely held corporation:

Has more than 50% of the value of its outstanding stock owned (directly or indirectly) by 5 or fewer individuals at any time during the last half of the tax year, and
Isn’t a personal service corporation.

To avoid getting their veils pierced, Nolo recommends that LLCs and corporations follow corporate formalities and avoid commingling assets.

Follow corporate formalities

In the words of Nolo, small corporations and LLCs can protect themselves by observing formalities such as:

holding annual meetings of directors and shareholders or members
keeping accurate, detailed records (called “minutes”) of important decisions that are made at the meetings
filing annual reports and paying fees to maintain good standing with the state
adopting company bylaws, and
making sure that officers and agents abide by those bylaws

Avoid commingling assets

A corporation can protect itself by never commingling corporate assets with personal ones. For example, never write a check from your company business account to make a payment on something personal, such as a mortgage. Keep a completely separate business account for your business.

Other steps you can take

Directors, shareholders and members of corporations or LLCs can also take the following steps to protect themselves, in the words of Nolo:

Make a reasonable initial investment in the corporation or LLC so that it is adequately capitalized.
Don’t tell a creditor that you will personally guarantee payment of the corporation or LLC’s debts.
Don’t use the corporation or LLC to engage in illegal, fraudulent, or reckless acts.

Make sure the world knows it is dealing with a corporation or LLC by conspicuously identifying the company status (that is, “Inc.” or “LLC”) on all business cards, letters, quotes, invoices, statements, directory listings, advertisements, and all other forms of company communication. When signing company documents, clearly state your representative capacity (such as, “Jane Doe, President, Acme LLC.”)

It may be scary to think that you could lose your limited liability, but it’s a preventable situation. By following the recommendations in this article, you can make sure that creditors won’t be able to go after your personal assets.

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