Behind the Veil

Until modern times the investors in a company were personally liable for its debts and other liabilities. The enactment of laws allowing investors in a company to limit their liability to the amount invested is reckoned by many economists as among the greatest of human innovations, unleashing huge investment in new enterprises. After all, who would buy shares in the electric car maker Tesla if share ownership included personal liability for all of Tesla’s debts?

Very small businesses, those with just one or two shareholders, likewise offer limited liability to shareholders. Under most circumstances the shareholders cannot be held responsible for the liabilities of a corporation, LLC or other limited liability company, a fact known and cherished by those of us who do business as a corporation or LLC. (In this article I’ll use corporation, company and LLC interchangeably. So far as limited liability law applies, each is about the same.)

But sometimes the shareholders can be held liable for what the corporation did, or what it owes. Sometimes, in the words that judges use, the corporate veil can be pierced.

One thing to keep in mind is that if the shareholder’s personal carelessness results in someone getting hurt, the shareholder can be sued personally, along with the company. For example, suppose a man owns and operates a convenience store under a corporation: he’s the sole shareholder. One winter day the guy forgets to mop a puddle by the door, ice forms, and a customer slips and is hurt. Does the company get sued? Sure, but so does the guy who forgot to mop, even if he is a shareholder. Strictly speaking that’s not veil-piercing, but it acts like it.

There’s no set rule for when a judge will allow the veil to be pierced, but here are some circumstances to avoid if you want your LLC or corporation to shield you from personal liability. I’ve arranged them in approximate order of importance, most to least.

Don’t do anything bad using the corporation. If, through your company, you defraud a customer or another investor, or slander someone, or steal, no court will allow you to avoid personal liability by hiding behind the corporate veil.

Do let the world know it’s doing business, not with you, but with a corporation. Your signs, checks, invoices, contracts, business cards and all other such documents must state the name of the company, as that name is registered with the Secretary of State. If these documents state your name, they must also state your title (“John Doe, President”). Basically, you do not want to put anyone in the position of being able to argue to a court that they had no reason to think they were doing business with anyone other than you personally.

If you want to use a shortened name or some other name, either file articles of name change or register the nickname as a “dba” (doing business as), again with the Secretary of State. I once won personal liability against a defendant because his road sign had a name different from his corporation’s name. (And also because he treated the corporate bank account as his piggy bank, see the next paragraph.)

Don’t treat the company’s money as though it’s your own. If, using corporate money, you buy groceries, vehicles and fuel for your own personal use, and attempt to treat those costs as corporate expenses, a court will likely disregard the corporation even for a liability unrelated to the improper expensing.

In my opinion it’s ok to write corporate checks for personal expenses IF those expenses are booked as dividends or similar distributions. However, many accountants prefer that their clients avoid writing corporate checks for personal expenses, and ask that they instead write a check representing a dividend or draw, deposit that check into a personal account, and pay the personal expense from the personal account. Consult your bean counter.

Some folks have several corporations, each conducting its own business. The financial books of each must be kept rigorously separate if a court is not to treat the liability of one company as the liability of all the companies.

Keep up with at least the minimal corporate formalities. Once upon a time a critical factor in whether a corporation would shield owners from personal liability was whether the company had regular meetings of the directors, an annual meeting of shareholders, kept good meeting minutes and so on. The role of such formalities in maintaining the corporate shield is diminished now. However, if you let your corporation lapse because you don’t file the annual report and pay the annual fee, or if you don’t have share certificates (for a corporation) or a register of membership interest (for an LLC), don’t expect the corporate shield to hold up. A similar result may occur if you do business in Maine through an out of state corporation but you don’t register that “foreign” corporation in Maine, again with the Secretary of State.

Don’t undercapitalize the company. If you take every penny out of the company as it comes in, and particularly if, anticipating a suit or other trouble, you transfer away all the corporation’s assets, a court will likely allow the veil to be pierced. In my opinion, at least where the liability is one for which a business insurance policy will provide coverage, the existence of a policy in some reasonable amount will forestall this argument even if the corporation is near broke. Conversely, if a court is faced with the circumstance where if the veil is not pierced an innocent injured person will get nothing, the court will want to find a way to get behind the veil.

I have a brief pamphlet which states how to make sure the corporate veil stands between you and personal liability. Send me an email or call me if you want one – no charge.

And stay out of trouble.

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