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Piercing The Corporate Veil

Piercing The Corporate Veil Print
One of the purposes of setting up an LLC or a corporation is to protect your personal assets and not expose them to your business obligations.  It is very important that you comply with corporate requirements so you can maintain the protection afforded by the LLC or the corporation.  If you fail to comply with the corporate requirements, a third party may effectively “pierce the corporate veil” and reach your personal assets to satisfy business obligations.   The following actions can put your personal assets at risk:  inadequately capitalizing the company, co-mingling your personal and corporate assets, failing to keep proper corporate records, and failing to hold and document company meetings.

Adequate Capitalization. The company should open a bank account for the company with sufficient funds to start operating the business.  There is no predetermined amount that is considered sufficient for adequate capitalization for your business.  It is important to be realistic about the type of business and the monetary needs to operate it.  Obviously, a consulting company that employs one individual and operates out of the owner’s home and has low overhead will need much less capital to start than a manufacturing company that has to buy equipment, pay for a lease on a manufacturing facility and hire employees to operate the business.  From my experience, clients always underestimate the amount of money it takes to start and operate a business.  I recommend they take their start up estimate and triple it and they will find themselves with a more realistic financial estimate.

Set Up A Company Bank Account – Avoid Co Mingling. The company should have a separate bank account for its operations.  At a minimum, the company should establish an operating account in the company’s business name.  The operating account will serve as the bank account for the business in which the company will deposit the revenue from its sales and pay its expenses.   It is very important that you do not use your personal bank account as your business bank account.  You cannot co-mingle your personal funds with your business funds – you need to keep your business separate from your personal finances and that requires separate bank accounts.  If you co-mingle business and personal funds, you blur the separation of personal and business and a court may determine that the separate nature of the business, on the one hand, and the individual, on the other, have ceased to exist, which then subjects your personal assets to company obligations.   For instance, you cannot use your business account to pay for your personal expenses, like your personal credit cards.   Similarly, you should never pay business debts from your personal bank account.  If your business needs additional capital to operate, you can lend the company money which should be documented with a simple promissory note and approved in company minutes.  The bottom line is you may be personally responsible for your company’s obligations if you don’t respect the separate nature of the business.

Keep Good Company Records. In light of the above information, it is important to appropriately document and approve company action.  Corporations are required to have annual shareholder and board of director meetings at which time they can document important company action taken over the course of the year.  While LLC’s are not required to hold annual meetings, it is a necessary business practice to hold regular company meetings to approve important company actions and document the reasons for those decisions.  Managers and members can hold meetings throughout the year, documenting the important decisions as they are made.  Alternatively, since most business owners are busy operating the business, managers and members can meet once at the end of the year to document and approve all company action.  If you do not hold meetings and take notes to document that you held the meeting, there is no record to show that action taken was on behalf of the company.  As a result of failing to document your company meetings, the Arizona courts, IRS, and creditors can determine that you have ignored your company’s separate existence and you have been acting as an individual, rather than acting through the LLC.  If this happens, the protection of the LLC may be “pierced” and you may be held personally responsible for the company’s actions and debts.  Check our article on Company Minutes for more helpful informaiton.   If you need assistance preparing your company minutes, please contact us.

Additional Helpful Measures.
There are a couple additional measures that you can take to prevent piercing the corporate veil.  Always use the company designation with the company name, such as “Inc.” “Company” or “LLC.”  If you do not use a company designation, there is no public representation that the business is incorporated and people may assume that it is a tradename which does not require incorporation and exposes personal assets of the owner.  If your company is a corporation or a limited liability company  ALWAYS use the company designation on all of your company material, including letterhead, invoices, checks, business cards, websites, marketing material, signs, etc.  It is important that the business enter into all contracts in the legal name of the company and that the appropriate company officer sign the contract using his/her title.  If you fail to use the company name with the company designation or if you fail to sign using your title, an argument can be made that you entered the contract personally, not with your business, and your personal assets are no longer protected.

By proactively putting the above measures in place, you will have taken significant steps to protect your personal assets and avoid exposing them to business creditors.

Prepared by
Joan L. Jakel
Business Attorney