How to Maintain Your Corporate Veil
From INCyclopedia, the incorporation encyclopedia
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The primary function of a business entity status such as a corporation or limited liability company (LLC) is to protect managers, owners, or shareholders from being held liable for debts and various legal responsibilities.
In the event that legal action is taken against an entity-protected organization, creditors or court-authorized officials are able to access the company's assets, but they may not dip into the personal finances of owners or shareholders--a protective stipulation that is not afforded to non-entity companies.
In some cases, however, such a breach is legally authorized1--a practice that is referred to as "piercing the corporate veil". In such circumstances, a court determines that a specific business entity, mainly a corporation or LLC, has conducted itself in a manner that violates provisions set forth by a legislative body and, therefore, the company's owners and stockholders may be held liable for certain financial or legal obligations.
This procedure usually stems from a creditor's allegations of fraud against a certain company, such that significant financial damages were levied on the creditor. If the accused entity is unable to match the assets as demanded by court judgment, the creditor is permitted to pierce the corporate veil by tapping the personal assets of owners and shareholders. Targeted assets2 can include bank savings, bonds, family heirlooms and even homes.
Protecting Your Corporate Veil
Business entities can safeguard themselves from corporate veil piercing by strictly adhering to corporate formalities such as maintaining operational and contractual agreements, allotting membership agreements and frequently updating shareholders and managers on company functions and procedures.
Many cases that substantiated piercing the corporate veil involved smaller corporations that, due to mere oversight of willful disregard, did not consider corporate formalities in conducting their operations.
A 2001 Connecticut case3, The Stone v. Frederick Hobby Associates II, LLC, involved the piercing of Frederick Hobby's self-titled LLC due to Hobby's failure to follow corporate formalities and procedures. The court also cited a lack of separation between "ownership and interest," suggesting Hobby's existence status as a separate entity never existed.
More specifically, businesses need to document all activities. These include financial transactions, investment initiatives and organizational decisions, as well as meetings, correspondence and legal proceedings (cf. "How to Keep Your Corporate Books", and "How to Keep Your Corporate Records").
Because fraudulent activity is the most common grounds for piercing the corporate veil, it is worth it to note noting that many businesses begin with the sole intent of defrauding investors and consumers. These activities should be avoided and discouraged entirely. What's more, courts are far less likely to sympathize in their decision to lift the corporate veil if the targeted business is found to be a sham.
Equally important is for business owners and managers to avoid mixing personal and business assets - that is, using business assets for personal use or vice versa. Either scenario will likely result in significant legal trouble.
As all businesses seek to be profitable, sometimes, due to adverse conditions or a decaying economy, a corporation can begin to see a loss in capital. If legal proceedings arise in such circumstances, piercing the corporate veil may be legitimized due to a lack of available capital. Investing personal assets, launching a joint venture or securing a business loan are all means of adequately capitalizing such a corporation.
In Kinney Shoe Corp. v. Polan, a 1991 case4 that utilized piercing of the corporate veil, Polan was found to have never held corporate meetings or elected officers, along with a number of other formalities that the corporation failed to administer. The case was to determine whether Kinney could pursue Mr. Polan individually for outstanding debts.
Judge Chapman, the ruling circuit judge for the U.S. Court of Appeals, argued in his statement:
This corporation was no more than a shell--a transparent shell. When nothing is invested in the corporation, the corporation provides no protection to its owner; nothing in, nothing out, no protection. If Polan wishes the protection of a corporation to limit his liability, he must follow the simple formalities of maintaining the corporation. This he failed to do, and he may not relieve his circumstances by saying Kinney should have known better.
Further Information
If you have questions about how to maintain your corporate veil, you may want to check out our forum discussions on corporate compliance.Footnotes
1. Corporate Veil2. Avoid Piercing the Corporate Veil
3. Corporate Veil Cases
4. Kinney Shoe Corp. v. Polan
Tags : Corporate Veil, Compliance, Limited Liability