What Is The Corporate Veil And How Can It Be Protected?

By: Will Barnard
Submitted: 10:33AM on Wednesday 05 November 2008

One of the primary advantages of forming an entity for your business is that the business owners are not held personally liable for the debts or liabilities of the company. In other word, creditors can only pursue the entity's assets and cannot reach the assets of the business owner. That line of protection, which separates the company's liabilities from the business owner's personal assets, is commonly known as the "Corporate Veil". Under some circumstances, if the owner does not follow the proper procedures, a creditor can pierce the "Corporate Veil" and reach the personal assets of the business owner.

While the law may differ slightly from state to state, there are a few common ways in which a business owner can lose the protection of the Corporate Veil.

1. ALTER EGO The most common way that the Corporate Veil is pierced is when the business owner is considered the "alter ego" of the company. This typically occurs where the company ignores the corporate formalities such that it is not recognized and treated as a separate entity by its owner. A short list of the formalities that should be followed are listed on page two of this Newsletter along with a list of recommended procedures.

2. FRAUD The second most common way in which the Corporate Veil is pierced occurs when a business owner commits fraud. This could be as simple as forming an entity, and then insuring liability in the name of the Company with no intention of repaying those liabilities. The business owner cannot rely on the protection of the Corporate Veil as a way to avoid payment for the liability.

The main principle here is that you cannot use the Corporate Veil to shield liabilities which you never intended on repaying. If ever litigated, the court may simply see the judgment creditor as being defrauded by the company.

3. GROSS NEGLIGENCE Another common way in which the Corporate Veil can be pierced occurs when the business commits acts which are grossly negligent or reckless. Gross negligence occurs when the business intentionally fails to perform duties or commits reckless acts. Ordinary negligence can arise from simple inadvertence. However, ordinary negligence is not enough to pierce the Corporate Veil. In sum, if a plaintiff can show that the business committed reckless or crossly negligent acts then a court may allow a plaintiff or creditor to pierce the corporate veil.

STEPS TO PROTECT THE CORPORATE VEIL

There are a number of recommended procedures that should be followed to ensure that your Corporate Veil is protected. By following these recommended procedures, you do not face personal liability for the operations and liabilities within your business.

1. Maintain an active status for your business entity with the states you are authorized to do business in. This usually requires a simple filing and payment of an annual fee to the State. Failing to stay current with the State will cause your entity to become in-active or delinquent and the state will assess you additional penalty fees for not meeting your annual deadlines. Moreover, if the entity is dissolved by the state, your protection ends on that date.

2. Own your business assets (e.g. real estate) in the name of the entity and execute all contracts and legal documents in the name of the entity. This may require new deeds or updates to contracts.

3. Hold annual meetings and complete annual minutes. This is required a requirement for Corporations and while it is not required of Limited Liability Companies ("LLC") or Limited Partnerships ("LP"), most practitioners still recommend that you follow through on these formalities.

4. Create letterhead and business cards for each business operation and use them. You want it to be clear that you are acting on behalf of your company and not in an individual capacity.

5. Maintain a separate checking account for each company and don't co-mingle business assets with personal assets. Using your personal account for business activities shows complete disregard for the Corporate Veil since you are not treating the company as a separate entity from the business owner.

6. Receive business income in the name of the business and pay for business expenses out of the business bank account(s).

Written by KKO Lawyers