In baseball, it is commonly said that the best offense is a good defense. That also rings true in corporate law, where proper company structure and efficient drafting of agreements can not only set your small business up for success, but also protect it from legal pitfalls. But what about small business owners? Are you, as the small business owner, protected? Can an individual or business that sues your company also sue you personally? What if you just own a piece of a company and have no active role in the operations? More importantly, can a creditor (a person/entity whom you owe money) force you to turn over your personal assets, drain your savings, empty the college fund you created for your children, or even force a sale of your home to satisfy a judgment? While other areas of law also play a role in protecting personal assets, a small business owner’s effective use of the “corporate veil” can make all the difference when it comes to preserving wealth and protecting business operations.
The Secretary of State oversees the registration of business entities, and the types of available entities vary greatly with regard to tax structure and liability. Statute-created business entities are designed to have a separate and distinct existence from their owners. As a result, business owners are not normally held personally liable for business debts. One type of business entity that offers protection to its owners is the “limited liability company” or “LLC.” While it may seem obvious, the intent behind the existence of LLC is to limit a company’s liability, to a creditor, to only the assets within the company. A “corporate veil”—an imaginary wall of sorts, protects personal assets of the owners by blocking a creditor from access. While the term “veil” is generally defined as a thin piece of material, it doubles as an incredibly strong protection mechanism by which business owners can insulate themselves. To “pierce the corporate veil” would require a court to disregard an entity’s separate status from its owners and instead hold its owners liable for the business debts. Piercing the corporate veil means that a business owner can lose all of their personal assets, even if they did nothing wrong. In what situation would a court disregard the entity’s separate status, putting a business owner’s personal assets at risk, and how does a business owner ensure that the corporate veil is not pierced?
Several Keys to a Strong Corporate Veil
The protection offered by an LLC is only as good as the owners’ commitment to maintaining that protection. Certain business practices, in addition to a lawyer’s guidance, should be consistently implemented:
- Separating business funds from personal funds. Never—never comingle assets. A business owner who pays personal bills directly from the company bank account is blurring the line between business and personal and giving creditors the opportunity to pierce the corporate veil as a result.
- For business transactions, always use the full legal name of the business. When signing documents, ensure that it’s clear that you are signing on behalf of the business by indicating your capacity (president, secretary) after your signature.
- Create and maintain an LLC operating agreement. So many small businesses that contact my office do not have an LLC operating agreement and do not understand the need, especially when the business is solely owned and has no other employees. Clear indication to a court (or to the IRS in case of an audit) that your company has operational guidelines, and that they are followed, will go a long way toward convincing a court that the business is separate from its owner. The smaller and more closely held the business, the more intensely the court may scrutinize it. Small business owners must pay particular attention to this issue.
- Paper any personal loans. It is common that a business owner loans personal funds to the business to cover down months. Be sure to create proper loan documentation so that it’s clear that the owner and the business are separate.
- Ensure the business and all related parties comply with all applicable rules, policies, and laws.
Failure to comply with any or all of these suggestions could put the small business owner’s personal assets at risk. Just as the business operations need daily attention, the business entity needs constant upkeep and attention to ensure maximum protection from liability. Protect everything you’ve worked so hard for—bulletproof your corporate veil!
How We Can Help
The Minasian Law Firm is here to help your small business meet all the formal legal requirements and offer additional consultation to protect your corporate veil. With our expertise and experience, you can leave the compliance headaches to us and focus on what matters most to you: growing your business. Contact me today.