Avoiding Personal Liability as an Entrepreneur

If you own an LLC or corporation, you are probably worried about liability protection. After all, the objective of these entities is to protect their owners from personal liability for the obligations of the business. Regretfully, while your LLC or corporation can assist you to escape personal liability in the majority of cases, claims against your company may get to you personally if you aren’t taking the necessary ongoing precautions. You may have heard of the saying "piercing the corporate veil" or thought about whether you might be held personally accountable for the business's debts or obligations. Piercing the veil is legal jargon that refers to the process through which an individual or business may seek to hold you personally responsible for the money owed by your business.

Understanding "Piercing the Veil"

When a court enables a plaintiff to take legal action straight against the owners of an LLC or corporation, this is known as 'piercing the corporate veil' (aka, going through the company to get to your personal assets). This is a serious remedy that courts only approve in exceptional situations. Small, closely owned businesses are the most likely to have their corporate veil pierced. Single or two-person businesses are less likely to comprehend or follow the necessary formalities of running a separate company. Moreover, small business are more likely to mingle their personal and corporate assets, jeopardizing their LLC's distinct identity.

The majority of veil piercing situations occur when a business owner fails to follow the legal requirements for managing a business, engages in fraudulent activity, or fails to separate his personal and corporate assets.

Piercing the Veil from the Plaintiff’s Perspective

Because it is assumed that you, as the owner, have taken (or will take) all of the cash out of the firm, piercing the corporate veil is frequently utilized against small enterprises. Consider your creditor's perspective, as well as that of an unhappy customer, supplier, former business partner, or even a former employee who is considering filing a lawsuit. They believe (or expect) that if they sue the company, you'll just take all of the money out, hide any assets, or close down the company to escape liability. So, rather than just suing the company, they sue both the company and the owner(s). To accomplish this, they employ the idea of veil piercing. If the plaintiff suspects that the parent entity has significantly more resources than the subsidiary entity, the plaintiff will attempt to use veil piercing to get access to the parent entity's assets or the individual owners' assets.

When Will the Corporate Veil Be Pierced by the Courts?

When all of the following are true, courts may penetrate the corporation veil and impose personal culpability on officers, directors, shareholders, or members.

• The company and its owners do not have a clear separation. A court may discover that the corporation or LLC is really just a sham (the owners' alter ego) and that the owners are personally running the business as if the corporation or LLC didn't exist if the owners fail to keep a formal legal separation between their business and their personal financial affairs. For instance, if the owner pays personal bills from the business checking account or fails to follow the legal requirements that a corporation or LLC must follow (for example, by making important corporate or LLC decisions without recording them in minutes of a meeting), a court could rule that the owner isn't obligated to the limited liability that a corporation or LLC would normally provide.
• The company's activities were illegal or deceptive. A court might decide fraud was committed and that the limited liability protection should not apply if the owner(s) irresponsibly borrowed and lost money, struck commercial transactions knowing the firm couldn't pay the bills, or otherwise acted recklessly or dishonestly.
• The corporate creditors have suffered. If a person who did business with the company is left with unpaid invoices or an unpaid court judgment, and the following conditions are present, a court will attempt to remedy the injustice by piercing the veil.

Piercing the Corporate Veil's Consequences

The owners, shareholders, or members of a corporation or LLC might be held personally responsible for corporate obligations if the corporate veil is pierced by a court. To settle the corporate debt, creditors might go after the owners' house, bank account, investments, and other assets.

Protecting Yourself from Veil Piercing

• Keeping track of your company's activities. Keep track of all of your key business decisions and meetings. Sign and preserve contracts that your company joins, for example. Keep track of the inaugural and annual meetings of directors and shareholders (corporations) or members/managers (LLCs) that you had, as well as the minutes of each of these meetings, and keep the record for at least five years.
• Don't mix your company and personal finances. Separate your company assets from your personal assets. Only use a business checking account and a business credit card for company spending. Separate your assets, such as equipment and property investment.
• Maintain sufficient capital. To get started and stay in business, you'll need money as well as the required equipment and supplies. You may achieve this in a variety of ways, including using your own money, accepting money from others and turning them into business owners, or taking out a business loan. Your firm will not exist without enough money, regardless of your strategy. Keep in mind that this money is supposed to go to your business, not you. All money put into companies should be documented as capital contributions or loans to the company.
• Declare if you're a corporation or a limited liability company. Make business cards with your company's and LLC's names on them. Using a company bank account or credit card, make purchases and pay bills. To send to your clients, create invoices under the company name. In addition, any contracts, leases, or papers you sign should be in the name of the company.