Piercing the Corporate Veil

*Photo by Margaret Darms is licensed under CC 2.0. *

LLCs and corporations are so valuable because they offer limited liability protection to their owners. This means that the debts, obligations, and liabilities of the business belong to the business alone and not to the business owners. So, for example, a court judgment against a business cannot reach an owner’s personal assets to satisfy the resulting liability.

Limited liability protection is, however, premised on the notion that the business exists as a separate entity, distinct from its owners. Where as a practical matter this is not the case, limited liability protection may be lost. This is known as piercing the corporate veil, or simply piercing the veil.

Piercing the Corporate Veil

Piercing the corporate veil is a legal concept that holds that where the identities of the business and its owners are indistinguishable, maintaining their separateness solely for liability purposes is unjust. The concept of piercing the veil holds that a business and its owners are either distinct or indistinguishable; they cannot be distinct solely for the purpose of providing limited liability protection.

Piercing the corporate veil is not something that courts take lightly, but when it occurs, the results can be dramatic. A business owner may find himself in court realizing that that lawsuit against his business is now also a lawsuit against him personally. Maintaining distinction between business and business owner is therefore critical.

What Does It Take to Pierce the Veil?

In order to pierce the veil, the company must be nothing more than an altar ego for the owners or no more than the instrumentality of the shareholders. (These two rules are very similar, if not exactly the same.)

Some characteristics of a company that may pierce the veil include:

1. Gross undercapitalization of the business. This prevents the financial independences of the business, making it simply an extension of the owners’ finances.
2. Lack of observance of required formalities, such as voting, adhering to the provisions of the operating agreement, or annual meetings.
3. Using business employees to perform personal tasks for business owners.

This list is not exhaustive but simply highlights some of the marks of indistinguishability between business and owner for which the courts look when considering whether it would be just to declare that there has been a piercing of the veil.

For a business to exist separately from its owners for the purposes of legal liability, there must be a clear distinction between the business and the owners. To pierce the veil is a serious matter. Therefore, great care should be taken to divide personal and business assets and tasks to ensure that a court does not determine that your business is simply an extension of yourself. If that happens, watch out.

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See Also:

The Corporation

The S Corporation