Business owners need to take legal steps to protect themselves from being held personally liable for the debts and actions of their business.
The "corporate veil" in corporations law refers to the legal separation between a business and its owners. This separation is a metaphorical "veil" distinguishing the two, and protects individual owners from being personally liable for the business' debts or legal issues.
Courts can 'pierce the corporate veil' and hold individual owners and directors accountable based on the way in which they interact with the company.
Business owners often make a number of mistakes that can result in a court piercing the corporate veil. This could lead to personal liability for the owners, as the court may consider their business to be their "alter ego" rather than a legally separate entity. Here are several examples:
Mixing Personal and Business Funds
Mixing personal funds with company funds is an easy way to expose yourself to personal liability. Even in a single member LLC, owners or partners should never keep their personal funds in the same account as the funds to be used for their company.
Depositing Money
If you are putting funds into your business, it should be done so as an additional capital contribution that results in an additional ownership stake in the business, or as a loan. When you put personal money into the business in the form of a loan you should draft and sign a promissory note that requires the loan to be paid back to you with interest.
Withdrawing Money
Similarly, when withdrawing money, it must be in the form of a paycheck or through a shareholder or owner distribution. Both of these methods require authorization in your operating agreement, a written consent, or some form authorization among owners to make such a distribution.
Following Your Operating Agreement or Bylaws
Your corporation or LLC must conduct business based on its operating documents and state law. In the case of a corporation, it is important to hold regular meetings and convene for major decisions such as large purchases, sales, investments, and borrowing. Additionally, there are annual filing requirements for the state, finances, and other business aspects that need to be accounted for. While basic, these are all indicators whether an entity should be treated as separate from its owners.
It is crucial to conduct and properly document all business activities to mitigate personal liability. Failure to comply with these regulations may result in a breach of proper business conduct, which could lead to the courts disregarding the legal separation between the business and its owners.
Most LLCs are not required to hold member meetings, but doing so - especially when making a "major decision" - provides strong support that the business operates separately from its owners.
Capitalization
This is a common problem that arises when dealing with entities that primarily serve as conduits for managing other entities. It is crucial to contribute sufficient capital to cover anticipated expenses and liabilities during the initial months of the business. Insufficient capitalization can jeopardize personal liability protections.
Separate Yourself from a Single-Member LLC
A single-member LLC, while being one of the most common forms of limited liability companies, can also be vulnerable to the piercing of the corporate veil. It is easy to perceive a single-member LLC as the alter ego of its sole member, which undermines the protections intended to shield partners from lawsuits. If you own a single-member LLC, it is particularly crucial to adhere to basic formalities that demonstrate the business operates separately from your personal finances.