If you own a business, undoubtedly you have heard the phrase “piercing the corporate veil” or you may have wondered whether you could personally be held liable for the debts or obligations of the business. Piercing the veil (which also applies to limited liability companies) is the method in which a person or business could seek to hold you personally liable for money owed by your business.
The “corporate shield” generally protects the owners of a business from personal liability for actions by creditors and others against the business. In its most simplistic form, the “corporate shield” ensures that the owner of the business will not be personally responsible for the business’ debts or torts.
Piercing the corporate veil generally becomes an issue when the business is being sued and the plaintiff is concerned that the business alone will be unable to satisfy the debt or otherwise pay a judgment and thus the plaintiff seeks to hold the owner liable for the business’ actions; i.e. “piercing the corporate veil”. Because the owners want to ensure that they are not personally liable for the business’ obligations, and because the plaintiff wants to ensure that they are paid (whether it be by the business or the owners individually), there has been substantial case law dealing with the relevant factors necessary in piercing the corporate veil. The factors the courts analyze in determining whether to pierce the corporate veil are the same factors the prudent business owner or business attorney should be familiar with to ensure the corporate shield is maintained.
Piercing the corporate veil and alter ego liability are what are called equitable remedies. A court may pierce the corporate veil to hold an owner liable for the acts of the business if the business was used for a fraudulent purpose (piercing the corporate veil) or if the owner is the alter ego of the business.
A two-prong test is applied to determine when a creditor will be allowed to pierce the corporate veil of protection from personal liability and hold an owner liable. The first prong focuses on the owner’s relationship with the business to determine whether the business was formed as the owner’s alter ego or mere instrumentality. The ultimate question on the first prong is whether the individual(s) treated the business as a separate entity entitling him or her to “hide behind it to avoid liability.” The second prong requires a showing that piercing the corporate veil is necessary to avoid injustice or fundamental unfairness.
To help avoid having the corporate veil pierced against you, it is necessary to treat your business separate from yourself. The business should have its own bank account(s). You should not pay your personal bills from the business’ checking account, and vice versa. If your business signs contracts, make sure they are in the name of the business and not your name personally.
We have litigated the veil piercing claim from both the debtor’s, creditor’s and business’ side. We have also worked with clients to protect them from the start to best insulate themselves from veil piercing claims. Reach out to us regarding your veil piercing questions.