Read on to learn the rules about piercing the corporate veil. Learn about other ways you can become personally liable for corporate debt.
What Does Piercing the Corporate Veil Mean?
The term ‘corporate veil’, or corporate shield, is used to describe the segregation of businesses from their owners. It is primarily designed for liability purposes, and as a separate entity, an LLC or a corporation can protect its members/owners from the negligence, debts, or mismanagement of the business. This way, the liabilities of the business remain that of the business, and owners are protected.
The overall concept of the corporate veil is very important to the concept of limited liability offered by both corporations and LLCs. Legally, if a business entity is considered totally segregated from its owners, owners can never be held for the company’s doing and are protected by the law. The concept of the corporate veil is paramount in understanding how businesses and individuals are two different existences.
However, while the owners enjoy the corporate veil, it is not always guaranteed. Under some conditions, the court can decide to pierce the corporate veil of a corporation or an LLC. It will expose the personal assets of the owners/members, and they will not remain a separate legal entity from their business.
When The Courts May Pierce the Corporate Veil?
There could be a variety of reasons for piercing the corporate veil, as discussed earlier in the article. Here, we shall take a look at some of the most common examples that cause the corporate veil to be lifted for corporations and limited liability companies:
- Failure Of the Corporation/LLC To Maintain Separate Identities
It is one of the most common reasons behind the piercing of the corporate veil. The usual circumstances where a situation like this may arise are where the members/owners create an LLC or corporation but keep on operating by personal accounts. Legally, this causes a failure to recognize corporate formalities, and the assets of the corporations or LLCs are used in a way as they are personal assets.
- Failure To Follow Corporate Formalities
This has to be the second biggest reason behind the piercing of the corporate veil for LLCs and corporations. When we look at the history of cases where the corporate formalities have not been held properly, courts have often held the stance that the legal liability protection of the members/shareholders was effectively relinquished, and the personal assets of the members/owners/shareholders are accessible to the claimant. This is most often seen in smaller businesses, which generally tend to be less diligent when it comes to maintaining corporate records.
- Existence Of Fraud in Dealings with Third Parties
It is one of the biggest red flags for courts to pierce the corporate veil of many corporations and LLCs. In the majority of the cases of this type, claimants are looking to pierce to corporate veil because of fraudulent activities by the owners/members of corporations and limited liability companies. One of the common examples of fraud in corporations is when a corporation closes itself down after being unable to pay the judgement and shifts its assets to another similar corporation.
When Can Business Owners Be Sued Personally?
While unless you are a corporation’s owner or a member of an LLC, you are always at the risk of being sued; but there is a lot more to being sued personally than what the eye catches at first sight. Corporations and LLCs offer a legal way where business’ liability is not transferred to the owners/members, and they can’t be held personally responsible for any of the business’s debts.
When you are operating a business without the protection of limited liability as offered by corporations and LLCs, you can be sued anytime, and if you lose your case, your personal assets will be on the line along with your business. With corporations and LLCs, there is extensive liability protection, but it is not permanent.
When a business is found guilty of malpractices or when it doesn’t maintain accurate financial records, it could be at the risk of having the limited liability protection gone. Once this happens, the assets of the owners and members can be sued, and members can be sued personally for their part in the fraudulent activity or for negligence in the duties of running a business.
When Piercing the Corporate Veil Occurs, What Happens?
Once a court decides to pierce the corporate veil of a corporation or an LLC, the owners, members, and shareholders will be personally held liable for all the wrongdoings of the company and what it owes to its creditors.
This also means that the creditors of the corporation or LLC, among others, can legally go after the owners’ investments, home, bank account, and all types of assets to fulfil the responsibility of the debt owed by the company.
However, in cases like where there is a partnership in a corporation, the courts usually will not impose any kind of personal liability on partners who were not responsible for fraudulent activities and wrongful business of the corporation, and only those members/owners will be held responsible who played a part in malpractices of a corporation, or an LLC.
Piercing The Corporate Veil UK
It was the English law that recognized the corporate veil a long time ago and granted corporations a separate legal identity from the individuals who own them. However, the companies’ law of the UK does have provisions for what it refers to as ‘lifting the corporate veil.
If a corporation or a limited liability company goes insolvent in the United Kingdom, there are certain situations where the courts can lift the corporate veil on a limited company and can make its members contribute to paying off all the possible outstanding debts to creditors. However, unlike in the USA, in England, to pierce the corporate veil, the range of circumstances is heavily limited.
This is historically linked to come from the “principle” in Salomon v A Salomon & Co Ltd. In this leading case, a cobbler from Whitechapel registered the business under the companies act of 1862. At that time, seven people were legally required to form one company.
Mr Salomon, being the only person in the venture, met this requirement by registering six family members, with one share each. Then, in return for the money that was lent to the company, his company issued a debenture, which secured his debt in priority to other creditors if there comes an event of insolvency.
The company of Mr Salomon did eventually go insolvent. The company’s liquidator, on behalf of all the creditors, tried to sue Mr Salomon personally. And even the court of appeal did hold that Mr Salomon had defeated Parliament’s basic purpose in registering dummy shareholders.
It would have made him indemnify the company, but the House of Lords held that so long as the formal legal requirements of making the company were met, the assets of each shareholder must be treated as separate from the ones of the company. This ensured that there could not, in general, be any corporate piercing of the veil.
In this section, we shall take a look into some of the frequently asked questions about piercing the corporate veil and the consequences that come with it:
- What Is Piercing the Corporate Veil and When Would It Occur?
Piercing the corporate veil is a legal decision that treats the duties and rights of a corporation as the duties and the rights of the shareholders, thus effectively ending the limited liability afforded to the corporation. Courts may decide to pierce the corporate veil when they find no real separation between the business entity and the individual or when the corporation is found in some wrongful/unlawful activities.
- How Do You Avoid Piercing the Corporate Veil?
It is not a difficult task, and with only fulfilling your corporate responsibilities, you can avoid piercing the corporate veil. All you have to do is to undertake all the necessary formalities, document all the business actions, make the status of your LLC known, and avoid commingling personal and business assets.
- How Does the Corporate Veil Work with Partners in Partnerships?
In limited partnerships, only limited partners have limited liability. Furthermore, in a limited partnership, piercing the veil usually requires evidence that the limited partner actually participated in the control of the business by taking action, not within normal roles of limited partners, or that the limited partners acted in a way to dominate the limited partnership or they used the limited partnership to perpetuate injustice or fraud.
- Why Is Piercing the Corporate Veil Important?
As we understand now, the legal distinction between yourself and your company is referred to as the “corporate veil.” If, over time, you have failed to legitimately keep this separation of entities intact, courts in the USA may “pierce the corporate veil”. It is important to avoid the illegal activities by the LLC and to fairly compensate the business creditors.
- How Difficult Is It to Pierce the Corporate Veil?
It is quite difficult and often takes a long time. It is also an expensive option to get a judgment against the individual who is behind the corporation because corporate laws are designed in a way to protect the corporations and individuals running them. However, it can be easy in a way when the debtor’s check register is available to the court, and the payees listed on those are indicative of all the incurred personal expenses.