The purpose of setting up a business entity is to protect yourself – as a founder, officer, director, or shareholder – from personal liability for your business’ debts and legal obligations. The law recognizes a corporation as a separate legal “person” for liability purposes. This means that if a third-party obtains a judgment against your company, only your business assets will be at risk and not your personal bank accounts, car, home, or personal property.
But even if you set up a business entity, you might still be at risk. If the legal separation between you and your business breaks down, you might lose your limited liability protection. In other words, a business creditor or someone injured by your business might also be permitted to “pierce” the corporate liability shield and get to you individually.
In this article, we explain what “piercing the corporate veil” means and how you can protect yourself from these claims.
What is the “corporate veil,” and how is it pierced?
The “corporate veil” is not a legal term of art, but is used to describe the liability protection that individuals gain when they set up a corporate entity rather than operating as a sole proprietor. A corporate entity is its own legal person with rights and obligations, considered distinct from the individuals who hold ownership interests in it.
The term “piercing the corporate veil” refers to cases when corporate officers or owners are held personally liable for the actions of one of their companies. This happens in situations where a court determines that the individual and company are not sufficiently distinct and the corporation and individual are treated as one and the same. For instance, if an individual business owner operates multiple shell companies out of a single administrative structure and frequently moves funds back and forth, or an owner uses corporate bank accounts to pay personal bills, or the officer of a company fails to comply with certain corporate formalities like holding meetings, paying dividends, or voting, a judge or jury might find that the business is operating as a mere “alter ego” of the business owner. When this happens, the law will no longer recognize the legal protection afforded to the separate corporate entity.
In North Carolina, a creditor or injured party who wants to hold an individual liable for a corporation’s debts or liabilities has to prove that the company had no separate existence or will of its own, and the individual in control of the company used his or her control to violate the rights of a third-party. Courts examine several factors in determining whether a company truly has a separate existence from the individual owner for the purposes of piercing the corporate veil. Among these factors are whether:
- The company was inadequately capitalized.
- The company’s directors, shareholders, officers, members, managers, or partners did not comply with corporate formalities typical of similar companies.
- The company was insolvent.
- The company was fragmented into multiple “shell” companies.
- The individual at issue siphoned funds from the company to pay personal expenses or debts.
- The company didn’t maintain proper records.
How to protect yourself
There are a few steps you can take as a business owner to protect yourself from these types of claims.
- When you form a company, be sure to make an initial capital contribution that is sufficient to cover the initial capital needs of the enterprise.
- Keep your business and personal accounts separate.
- Keep and observe your corporate bylaws.
- Comply with all corporate formalities like voting and paying dividends to shareholders.
- Keep regular minutes of board, shareholder, or member meetings (this will also be helpful if you are ever audited).
- Keep consistent and accurate corporate records.
- Don’t operate multiple shell companies that are separate in name only without any separate assets or operational existence.
- Don’t transfer money back and forth between shell companies without appropriately segregating income and expenses.
- Don’t use money from your corporate accounts to pay your personal expenses.
- When starting a new company, make the relatively minor investment of consulting with an experienced attorney rather than buying fill-in the blank forms from a national corporation mill. What might look like an opportunity to save a few bucks forming your own company could cost you thousands of dollars later on.
At Miller Monroe & Plyler, we help creditors and other aggrieved parties get through shell companies and pierce the corporate veil to hold individual owners liable for their company’s obligations. This experience also allows us to more effectively advise our business clients on taking the proper steps to insulate themselves from personal liability, which can be easily avoided with the advice of an experienced attorney. Contact us if you need help going after a business owner operating shell companies, or if you have questions about your business model and whether you may be susceptible to personal liability.