The principal reason for forming a new business is to enjoy the protection that it provides. Business owners who choose to incorporate as a corporation or form a limited liability company (LLC) are afforded protection from their personal assets being taken for debts owed by the company. This protection also applies to members and shareholders as well.
This protection can be taken away if piercing the corporate veil occurs. Piercing the veil takes place when a court concludes that the business entity was merely serving as an “alter ego” for its members. At this point, the owners are treated as if they are agents of the corporation, thereby exposing them to personal liability. A major factor used to justify piercing the veil is when members deviate from corporate formalities.
So how do you prevent piercing the corporate veil? First and foremost, the business must maintain its own bank accounts and credit cards. Also, any transfer between the owners and the business or any payments of any kind to the owners must be accounted for. Following these formalities allows owners to avoid “commingling”, which is a common reason a veil is pierced.
Aside from keeping separate accounts, it is important (if you’re a corporation) to keep your corporate records up to date. This mean to regularly update your bylaws and purchase and keep a minute book for your board meetings, which should be signed by the directors and officers. Also, share certificates should be issued and a stock ledger maintained. Another important task for corporations is to pay any required annual filings in a timely manner and pay your corporate taxes.
Similar to corporations, LLCs must also undertake any annual filings in a timely manner. LLC members should also create and regularly update an operating agreement. Membership certificates and a transfer ledger should be maintained, as well as holding initial and annual meetings of the members (and managers, if your LLC is manager managed).
Another way for corporations and LLCs to avoid piercing the corporate veil is to make its corporate or LLC status publicly known. A business can achieve this by creating business cards that display the name of the corporation or LLC. Business should also make purchases and pay invoices with its business checking account or credit card. Invoices should be created as well as any contracts, leases and/or documents should be in the company name. Both corporations and LLCs should have active officers and/or directors for their company. If the entity is merely the owner(s) making all of the decisions then there is a good chance a court would scrutinize the company as merely an “alter ego” of the business owner.
As you can see, there are numerous things to maintain in order to prevent piercing the corporate veil. Like most things legal, it is crucial to stay ahead of the game rather than playing costly catch-up down the road.