When you incorporate your small business as either a formal corporation or an LLC, one of the most powerful protections that you obtain is the corporate veil. The corporate veil protects your business assets as well as your personal assets. The biggest benefit it offers occurs when the business accrues more debt than it can pay. At that time, creditors can seize just about anything in the business itself, but they cannot pierce the corporate veil to reach your personal assets for debt satisfaction.
The General Analysis
When you find yourself in a position where your creditors are trying to get your personal assets, you generally don’t have to do anything to protect your personal assets. In most states, the creditors have to petition the court to be able to reach those personal assets. When that happens, the court orders a hearing. During this hearing, the court hears evidence about why the corporate veil should be pierced.
According to the sites that LegalZoom reviews, the burden is on the creditors. They have to establish that the manner in which you have handled your business is such that it does not deserve the protection of the corporate veil or that you have so blurred the identity of the corporation and your personal finances that there should be no distinction. Most states analyze this on a factor scale, meaning that the more factors that are present, the more likely the corporate veil can be pierced. Decisions can generally be appealed, but you will have to file an injunction to prevent the creditors from reaching personal assets if the court decides against you.
The Basic Factors
The court’s decision relies primarily on the factor based tasks, but each state has slightly different factors. According to Business Law for Beginners, the most basic factors that the court looks to include the following:
- Publicly traded or close corporation
- Compliance with corporate formalities
- Fraudulent misrepresentations
- Shareholder, officer, director identity overlap
- Personal and corporate fund mingling
- Lack of records
- Individual payments made for personal obligations out of corporate funds
With a few exceptions, most of these factors are not in and of themselves evidence of corporate mishandling, but they all lean toward a business that has not maintained itself in a sufficiently professional manner. The distinction between public and close corporation focuses primarily on the increased standard that close corporations have because of their extra benefits. In most states, a close corporation is a privately owned corporation that has less than 50 shareholders.
The Most Important Factors
While most states, including Delaware, the most common state for incorporation and corporate veil appeals, insist that no single factor is more important than another, some factors do have more weight in the big picture. Fraudulent misrepresentations and lying are both powerful indicators of corporate abuse. If they can be proven, this factor can sometimes be enough alone to warrant the piercing of the corporate veil.
The most common reasons for piercing the veil, however, relate primarily to the management of business formalities and finances. In small corporations, the shareholder/officer/director identity overlap is fairly common. After all, not all corporations are open to public funding, and that does not mean that there’s anything wrong with their form. But mingling corporate and personal funds as well is a lack of compliance with corporate formalities and a failure to keep good records result in a significant bias against the business owner. These factors, when combined with one another, paint a very strong picture, and most courts are inclined to find in the creditors’ favor because it appears that the business owner has been using the corporate form to benefit himself personally rather than the business.
In some cases, a business may unintentionally make it appear that it has behaved improperly when it has really just been careless. The simplest way is by having a shared bank account for personal and corporate funds. Even if the books keep these funds entirely separate, a shared account is enough to get the business owner in serious trouble in most states.
To help avoid the potential loss of the corporate veil, it is important that you as the business owner observed all formalities required by your state. Do not mingle funds at any time. If you need money from the business for some reason, pay it directly into your personal account rather than paying the creditor of a personal debt from your business account. The clearer you make the divide between your business and your personal finances, the safer your business will be.