Piercing the Corporate Veil - part 2

In my last post I looked at the factors involved in piercing the corporate veil. Now I want to focus on how you, as a business owner or director, can protect yourself. Some of these tips might seem obvious, but I recently ran into a case in which the owners were using the company as their own personal checkbook, so I guess this is not as obvious as it appears.

1. Money

Keep the company money separate from your personal money. Not only does this mean opening up separate accounts, but also giving yourself little reminders that keep the money separate. This includes using different banks for corporate and personal accounts so you'll know which is which just by seeing an envelope. You should even choose different check colors so you don't get them confused, even accidentally.

Once you have that set, do not pay your personal expenses from the company account. I know it might seem silly to write a check from the company to you personally and then turn around and write a check for the exact same amount for say,the home mortgage, but that is how it must be done. The amount of the corporate check is part of your salary and should be noted as such. If you lend money to the company or vice versa, write a promissory note. Again, I know it seems redundant writing a promissory note where you sign on behalf of the company and sign individually, but you must keep the money straight and your records accurate and complete. In addition, balance your check book regularly and review bank statements, even if someone else is helping you with the books. As I discussed in an earlier post, check fraud can be very detrimental to a business so pay attention to the money.

On the same theory, get a separate credit card for your business. Use it only for business expenses -- no exceptions!

2. Financing

If you create a corporation or a limited liability company be sure that the entity has adequate financing. That is, the company should be able to pay its own bills from its own checking account and should not take on obligations for which it cannot pay. This may mean that the entity needs to take a loan from you or obtain funding some other way (venture capital funding, angel investors). However the funding is accomplished, appropriate paperwork should be completed, particularly if you, the sole owner will be pouring your funds into this proposition.

3. Corporate formalities

A company must observe corporate formalities, meaning that you must have annual meetings and minutes from those meetings. If you want to take action, take a vote, create a resolution. Issue stock certificates. Run your company as if there were 500 stockholders and not just one and that each position of officer and director were filled by different, unrelated people. The treasurer is the one who should be in charge of he money; the secretary should maintain the corporate minutes. All this may seem horribly obvious, but these formalities and distinctions between you and your entity can quickly fade away when you are pre-occupied with actually doing what your business does. However, you cannot forget that you have to run and maintain the business part of your business in addition to whatever your business does.

Piercing the Corporate Veil

One of the key issues with a private business is that the company and the individual often appear to be the same thing. However, in the eyes of the law a corporation is a very different entity from the person who owns it.

That separation is known in the legal world as the "Corporate Veil" and while it often offers protection for both sides, especially when it comes to issues of assets and liability, sometimes it's used as an unfair shield, forcing plaintiffs to find a way through, or, as we like to say, Pierce the Corporate Veil.

When the corporate veil is pierced, the court looks through the corporation to find either a related corporation or an individual liable for the wrongdoing of the corporation. It happens that a few unreturned bread racks are a the heart of this issue. Back in the 60s, Cumberland Farms worked out a deal with My Bread Baking Company to sell bread in Cumberland Farms' stores. When the contract was up, Cumberland Farms didn't return some racks, resulting a 1968 decision called My Bread Baking Co. v. Cumberland Farms, Inc., which states that it is appropriate to pierce the corporate veil:

(a) when there is active and direct participation by the representatives of one corporation, apparently exercising some form of pervasive control, in the activities of another and there is some fraudulent or injurious consequence of the inter-corporate relationship, or (b) when there is a confused intermingling of activity of two or more corporations engaged in a common enterprise with substantial disregard of the separate nature of the corporate entities, or serious ambiguity about the manner and capacity in which the various corporations and their respective representatives are acting. In such circumstances, in imposing liability upon one or more of a group of ‘closely identified’ corporations, a court ‘need not consider with nicety which of them’ ought to be held liable for the act of one corporation ‘for which the plaintiff deserves payment.’

The next question is why would a plaintiff try to pierce the corporate veil of a company? The answer nearly always has to do with the defendant company's inability to pay a judgment. If the plaintiff actually wants the money owed, they'll have to look for the resources. If your company is getting sued, clearly you do not want to be found liable for the company's acts or omissions.

So, how do you avoid your company's veil from being pierced? What steps can you take to minimize your individual liability?

To answer that we look to the 1991 case of Evans v. Multicon Construction Corp., which sets out 12 factors the court should consider when the trying to pierce the corporate veil.

1. common ownership
2. pervasive control
3. confused intermingling of business activity assets or management
4. thin capitalization
5. disregard of corporate formalities
6. lack of corporate records
7. no dividend payments
8. insolvency at the time of the transaction at issue
9. draining of corporate assets
10. shareholders using the corporation for transactions
11. non-functional officers and directors
12. using the corporation to promote fraud

That is a long list -- what does it mean really though? What are the practical steps that you need to take?

We'll touch on that in our next post

Protecting Your Personal Assets

You've decided to take the plunge and start your own business. You've formed an entity -- maybe its a corporation or a limited liability company -- you paid your fee at the Secretary of State's office and filed your papers. Now what? If you believe that this is all you have to do and you are protected from individual liability if your company gets sued, you are sorely mistaken.

If only it were that simple. Any type of entity, corporation, limited liability company, limited liability partnership or any other entity requires upkeep, maintenance, and attention to protect an individual from being liable. However, it is important to remember that maintaining corporate formalities does not provide absolute immunity from liability. Corporate officers are still responsible for their own torts. No corporate status will protect an officer or director who makes a misrepresentation to a third party.

The next few posts will focus on how to make sure that you, as an officer or director of a company minimize your personal exposure should your company get sued.