“The corporate veil” is the term used to describe the way that the liability of shareholders of a company is limited to their ownership in the company and does not extend to their personal assets. In one sense the “corporate veil” is a way of affirming that a corporation is a legally distinct entity, capable of incurring its own debts and obligations separate to those of it shareholders. The “corporate veil” is an important and valuable protection that is established when a corporation, LLC, or Limited Partnership is incorporated.
When a creditor or another party seeks judgment from a court to make the shareholders, directors, or officers of a corporation personally liable, they are asking the court to pierce the corporate veil.
This article will focus on maintaining the corporate veil (and preventing it being pierced) after it has been established. Establishing a corporate veil requires that the company:
- File the Articles of Incorporation
- Hold organizational meetings
- Provide the corporation with competent initial management
- Issue the corporation’s shares of stock
If you are unsure whether your company has completed each of these qualifying steps, consult with your attorney. A failure to properly establish the corporate veil will likely result in business owners not being able to take advantage of the protections the corporate veil can provide.
How to Maintain the Corporate Veil?
The protection of the corporate veil is maintained by keeping and following corporate formalities. These nine rules provide a set of guiding operating principles for maintaining the corporate veil while conducting business through a corporation.
- Fulfill all annual filing requirements. In many states, a corporation must file an annual report and pay an annual fee. If such filings are not completed in a timely fashion, the state may revoke the corporate charter and the corporation will cease to exist.
- Maintain internal corporate formalities. Corporate formalities include having a resident agent in their state of formation and in any state the company qualifies to do business in and establishing and following bylaws adopted by the Directors in their organizational meeting and provide the guidelines for the corporation’s future actions and corporate policy.
- Maintain a written record of corporate decisions. Formalities (including minutes) are required of corporations, but are advisable with LLCs. Even if a small group of people or a single person controls the corporation, it should conduct meetings and prepare records of such meetings. Shareholders and Directors conduct three types of meetings which should each be recorded through minutes of meetings: organizational meetings, annual meetings, and special meetings to discuss urgent items of business or to approve any legal or tax issues. Directors and/or Shareholders sign a document that contains the language of the corporation’s decision or resolution. Should a creditor seek to pierce the corporate veil at a later date, the corporation’s records will serve as evidence of its separate existence.
- Give corporate notice to the world. Individual Officers or Directors may be subject to personal liability if they act on the corporation’s behalf, but fail to clearly indicate that they are acting in their capacity as the corporation’s Officer or Director- this includes when signing contracts or otherwise obligating the company. If the corporation takes steps to ensure that others know that the corporation, and not an individual Officer or Director is acting, the corporate veil will be more likely to be preserved.
- Ensure the corporation has sufficient capital resources. A corporation should have sufficient resources to meet its short-term obligations. If the corporation is under-capitalized and cannot meet its short term obligations, a creditor may argue, and a court could accept the argument, that the corporation exists simply to help its owners shelter their assets.
- Maintaining a separation between corporate assets and personal assets. To prevent creditors from piercing the corporate veil, the corporation must maintain a separate bank account, file separate tax returns, and use corporate assets only for corporate purposes.
- Distributing corporate profits in the best interests of the company. All decisions regarding the distribution of a corporation’s profits or compensation for employees is subject to the discretion of the Board of Directors, and these decisions can be subject to review. A failure to make decisions in the company’s best interests can lead to the corporate veil being pierced.
- Separate bank accounts. Using a single bank account or co-mingling funds will give rise to the corporate veil being pierceable because the corporation is not being operated as a separate entity.
- Separate tax returns. Because you have obtained an EIN for your entity, you must now file a separate tax return with the IRS. Failure to file a separate return can lead to claims that you are not following corporate formalities. Speak with your attorney and your accountant if you have questions about tax filings.
Consequences and risks
If you or the corporate officers of a company fail to maintain the corporate veil, it can be pierced rendering the company’s shareholders personally responsible to the company’s creditors. This can bankrupt an individual.
Small LLCs are most likely to get their veils pierced. Small corporations are less likely to follow through on corporate formalities which make them more vulnerable to a piercing of their corporate veil. To avoid trouble, it’s best to play it safe. Small business owners may be more likely to commingle their personal assets with those of the corporation or LLC. To avoid trouble, the corporation should maintain its own bank account, and the owner should never use the company account for personal use or deposit checks payable to the company in a personal account.
If you have any questions about maintaining the corporate veil for your corporation, speak with your attorney.