Preserving the Shield: How Corporation Owners Can Avoid Piercing the Corporate Veil

By Elidia C. Dostal, Partner

When a business owner decides to form a corporation, they are taking a significant step toward protecting their personal assets from the potential liabilities of the business. The business owner is essentially creating a “shield” — and this shield, known as limited liability, is one of the main advantages of incorporating.?

However, maintaining this protection requires more than just filing the necessary paperwork. Adequate capitalization and strict adherence to corporate formalities are key aspects to protecting your limited liability. Let’s look at why these practices are critical for your corporation.

Adequate capitalization refers to the initial funding or financial support that a corporation receives. Having adequate capital ensures that the business can operate smoothly, pay its bills and weather financial downturns without resorting to desperate measures. If the corporation does not have adequate capitalization, the business owner may find themselves in the same position they would have been in had they owned a sole proprietorship. That is, they may be personally liable for business-related liabilities of a business.

The idea of piercing the veil comes in if a business owner finds themselves with inadequate capitalization. Generally, a creditor cannot gain access to a member’s personal assets to recover the business debts. That is one of the main reasons for incorporating over a sole proprietorship. That being said, a creditor can access the corporate assets to satisfy business debts. In the event that the business has insufficient assets to cover its debts, state laws allow courts to pierce the company’s veil of limited liability to determine whether the business has adequate capital.

Business owners also need to strictly adhere to corporate formalities, which are the rules and practices that maintain a clear separation between the corporation and its owner. This separation is vital for preserving limited liability. There are several actions a business owner can take to assure they are adhering to those formalities. One of those things is holding regular board meetings and documenting minutes from those meetings. Having proper company bylaws and operating agreements is another key component. Companies should also maintain organized records of financial transactions, contracts and business-related paperwork.

Another key component for adhering to corporate formalities and preserving that shield is having a clear financial separation between the business finances and personal (owner) finances. For example, separate bank accounts should be kept for the corporate and personal finances. This is a crucial way to demonstrate the corporation is a distinct legal entity. Filing annual reports, including taxes, is another important part of ensuring the corporate veil is not pierced.

Neglecting any of these aspects can lead to a situation where the limited liability is compromised, which could expose your personal assets to business-related liabilities. Therefore, it’s critical to make these practices an integral part of your business structure. One of the best things you can do as the owner of a corporation is work with an experienced business attorney who can assure you are following all the correct steps and maintaining your business so that shield is protected.?

Elidia C. Dostal is a business transactional and compliance attorney and partner with Vanst Law LLP. She serves business clients who understand the importance of involving an attorney at the front end of business transactions and compliance issues to avoid the high cost of litigation or regulatory fines. Elidia brings an expert understanding of the importance of thinking ahead to avoid potential future liabilities.