How to Avoid Piercing the Corporate Veil in your LLC

You are a savvy entrepreneur and you took the time to carefully research business entities (Smart!) and choose the entity that made sense for you. Because you understood that your personal assets were at risk for paying business debts with a sole proprietorship or partnership, you took the steps to form as an LLC or maybe even as a corporation. This was super proactive and helped you sleep at night knowing that you had limited liability and your personal assets were safe.

Again, because you’re sophisticated and serious about your business, you took steps to get an EIN and opened a business bank account. (Excellent ideas!).

Unfortunately, that does not mean that your personal assets are gold-plated and protected. There are situations where you could still be personally liable for business debts. In order for that to happen, you would need to be sued and the court would have to decide to “pierce the corporate veil.”

Sidebar: For whatever reason, the phrase “piercing the corporate veil” has always struck me as extraordinarily violent since the first time I encountered it in Civil Procedure class. But, despite the quasi-graphic terminology, it is a crucial concept for you to understand as a business owner.

When a court “pierces the corporate veil,” it means that a court will disregard the appearance of a business as a separate legal entity and hold the shareholders or members accountable for the business’s liability. 

Basically, it means that a court will say that a corporation or an LLC was not really truly separate from the owners and, therefore, the owners are personally liable for the business’s debts. The court determines that the LLC was essentially just an “alter ego” for the owner or members.

And if that happens, all that nice and safe liability protection that you thought you had, vanishes. Your home, car, investments, bank accounts, everything could be fair game to satisfy the judgment against your business.

What?! Don’t LLCs or Corporations provide limited liability? Isn’t that one of their key features? Usually, yes, but that protection is only available if the LLC or Corporation was truly distinct from the owners. You can’t just talk the talk, you have to walk the walk and truly act as if your business is totally separate from you.

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Even scarier, small or “closely held” corporations or LLCs with only one or two members are the most likely to have the corporate veil pierced. 

When will a court piece the corporate veil? 

There are three typical circumstances that make your business and you vulnerable to piercing the corporate veil.

1) Insufficient business funds;

2) Failure to separate business and personal affairs;

3) Engaging in fraudulent or illegal business activities.

How do you protect yourself from piercing the corporate veil of your LLC?

• Start up and run your business with sufficient money. 

  Businesses that are considered unfunded can be vulnerable to piercing the corporate veil. Here, the court would look to see if your business has enough money to cover its liabilities. If your business does not have enough cash, a court could conclude that there is no real separation between you and your business because your business could not stand on its own financially.

• Keep your personal and business affairs separate.

  • This is key. You should have separate business and personal bank accounts and you should not co-mingle your finances.  You should document any time you pay for business expenses with personal assets and pay yourself a set salary to avoid the appearance of using your business as an ATM. 

  • If you need to take money from the business for personal use, be sure it is documented as a formal draw, and do not simply pay your personal bills from the business account. Want to be extra secure? Have an accountant review your business finances regularly. 

  • Related, be sure to sign all business documents, on behalf of your company. You can include “as an authorized member of XYZ LLC,” “as an agent of XYZ LLC,” or even “owner of XYZ LLC,” or “manager of XYZ LLC,” below your signature to ensure it is clear you acting on the authority of the business.

  • And definitely follow your LLC Operating Agreement or Corporate Bylaws when making business decisions. Be sure to memorialize decisions as required by your operating documents. This is known as following corporate or business formalities.

  • Even if you are a single-member LLC, you need to have and follow an operating agreement. It might be the best way to prove that you the person are actually separated from you the business. It’s evidence that your business is following the same rules and guidelines of much bigger businesses and has policies in place that you adhere to.

• Don’t engage in wrongful or fraudulent business dealings.

  This one should be obvious but do not engage in illegal business activities. This could include borrowing money that you know you can’t repay or signing contracts you know that you cannot perform.

But, Kerry, what are the key things I need to do to prevent a court from piercing the corporate veil?

1. Have a totally separate business bank account with separate Stripe accounts, Paypal, Venmo, Cash App accounts, and separate credit and debit cards. Never cash cheques for one account with the other and make sure all draws are documents. Don’t even pay personal expenses from your business accounts and document any transfer of personal assets into the business.

2. Observe business formalities. This means carefully following your Operating Agreement. If you think that you don’t have an Operating Agreement, you actually do because you will assume to be following the default operating agreements of your state. So make sure to put the Operating Agreement that you want into place. It doesn’t need to be fancy but you do need to adhere to it.

Piercing the corporate veil is scary but you can set your business up for success and maximize that limited liability protection that your LLC provides by taking those two simple steps. It is worth the time and effort upfront to make sure you are actually enjoying the personal asset protection that an LLC or Corporation can you.

THIS ARTICLE IS NOT A SUBSTITUTE FOR LEGAL ADVICE AND IS OFFERED FOR INFORMATIONAL PURPOSES ONLY. EVERY SITUATION IS UNIQUE AND YOU SHOULD CONSULT A LOCAL ATTORNEY FOR ADVICE ON YOUR PARTICULAR CIRCUMSTANCES.