Many business owners’ worst fear is losing their home or their money in a lawsuit. For this reason, they incorporate their businesses. If you’re the owner of a corporation or other business entity, your personal assets are generally safe from legal action against the company because the entity is considered a separate legal person that will be liable for its own actions. A lot of things have to go wrong before your personal assets are at risk: you have to get sued, lose the lawsuit, have a judgment entered against you, and have no insurance coverage for the loss. If all of these things happen, incorporating may not be enough to protect personal assets.[1]A judgment creditor can find a way to “pierce the corporate veil.” [2]
What does it take to pierce the corporate veil? There are a few common scenarios in which this typically happens to business owners.
1) Personal Actions
As an owner or corporate officer of a business entity, authorizing, directing or in some meaningful sense actively participating in wrongful conduct will likely result in personal liability. The easiest way to avoid personal liability is to refrain from committing wrongful acts. It almost goes without saying that no matter what protection your corporate structure may offer, crime and fraud will likely result in personal liability.
2) Commingling Assets
The law treats a corporate entity like a fictitious person, so it is separate from its owners and acts independently, as long as the owners do not mix their own money with the company’s money. Avoid spending company money on personal expenses and make sure the company has separate accounts from your own. Owners, partners, and shareholders all have a responsibility to keep their assets separate from the company’s assets, which will help make sure that your company will be recognized as a separate entity.[3] Failure to maintain the separation of corporate and personal assets could be seen by a court as commingling—a which could result in your personal assets being available to pay creditors.
3) Failure to Follow Corporate Formalities
Some business entities have specific regulatory responsibilities that they must keep up in order to operate. Corporations in particular may have to hold regular board meetings, keep minutes of their meetings, establish bylaws, and more. Again, your failure to follow formalities may not be enough to risk your personal assets on its own, but it can lead to more serious allegations like fraud.
4) Insufficient Capitalization
While you can’t exactly be punished for failing to make money with your business, undercapitalization can weaken your liability safeguards. Your business is considered undercapitalized when it lacks the funds to reasonably pay its expenses, debts, and liabilities. A business owner who keeps money out of the business on purpose, perhaps to shield the owner’s other assets, may be committing fraud. If your actions are interpreted as fraud, you may be ordered to pay the other party from your own personal assets, since your company’s assets may not be enough to give fair compensation.
5) Owners failed to present the company as a business entity.
Aside from keeping finances separate, you should do everything you can to demonstrate that your company is a separate entity from its owners. Having a separate name, logo and other materials like business cards and signage can all contribute to the recognition of your company as its own business entity. Without the right presentation, courts may not consider your company to be an individual entity, leaving your personal assets at risk in a lawsuit context.
If you have any concerns about your company, such as its business structure, its operational duties, or a pending lawsuit, you should enlist the assistance of a competent attorney. At Muir & Associates, we understand the challenges that many business owners face on a regular basis. Get in touch to discuss your business law and civil litigation needs with a professional lawyer.
How should I structure my business to protect my personal assets?
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