by Chris SwiecickiWhat is “Lifting the Corporate Veil in Company Law?
Founders set up LLCs and other corporations to protect themselves from personal legal liability. The personal assets of members of an LLC are separate from their business assets. However, courts sometimes end the limited liability protection for owners, directors, and shareholders, an action called the lifting the corporate veil or piercing the corporate veil.
“Veil” refers to the protection from legal liability provided by LLCs and corporations. When a court lifts the corporate veil, it removes the shareholders’ protection from legal liability. Their personal assets will be included in any orders to repay creditors and other litigants.
Owners, directors, and shareholders need to do all they can to protect themselves from a court piercing the corporate veil—and the personal consequences that follow.
When Do Courts Lift the Corporate Veil?
Courts use caution when considering lifting the corporate veil because the principle of limited liability is a key part of corporate law. However, in cases where there is straightforward evidence of an egregious act of misconduct, courts are willing to pierce the corporate veil and impose personal liability. The misconduct may include fraud, wrongdoing, or abuse of the corporate form. In Missouri and in most other states, three factors must be present for a judge to pierce the corporate veil:
- The owner dominated finance, policy, and business practices around a transaction and the corporate entity did not have a “separate mind.”
- The owner’s control was used to defraud, violate a statute or other legal duty, or commit a dishonest or unjust act that hurt the plaintiff.
- The control is believed to have caused the injury or loss.
A Missouri appeals court reaffirmed the three requirements for lifting the corporate veil in a 2014 case, Hibbs v. Berger.
Can Minority Members Ask Courts to Pierce the Corporate Veil?
The Hibbs ruling is also known for the court’s decision on whether minority members may file claims against majority owners. Plaintiff Steve Hibbs claimed that Brian Berger, his former employer, owed him money. Hibbs owned 5% of one of Berger’s businesses. When the company started having money problems, Hibbs stopped getting paid.
The Missouri Court of Appeals ruled Hibbs, a minority member of an LLC, had a right to pierce the corporate veil. Then, the court considered whether the case met the three requirements for removing the protection offered by an LLC. The court decided there was not enough evidence to pierce the corporate veil.
Examples of Courts Piercing the Corporate Veil
Two high-profile examples of a court piercing the corporate veil took place in Florida:
- In Ocala Breeders’ Sales v. Hialeah, Inc., the court lifted the corporate veil to investigate reports of the corporate officers of Hialeah, Inc., unlawfully running a subsidiary. The look behind the corporate veil revealed the subsidiary was no more than an instrument of the parent company. Hialeah, Inc., did not have enough capital and thus could not meet its obligations.
- In Broward Marine, Inc. v. S/V Zeus, the court lifted the veil of a yacht company to reveal the dominant shareholder’s evasive moves to avoid paying the plaintiff the money he owed him. The court found the defendant transferred all the company’s assets to another business he owned and hid the transaction. A judge ruled the dominant shareholder and his other company both were liable for the debt.
Florida courts followed the same guidelines for piercing the corporate veil as Missouri courts do.
Bad Business Practices Leading to Lifting the Corporate Veil
Courts are more likely to strip protection from legal liability–pierce the corporate veil–of companies guilty of one or more of these bad business practices:
- Commingling funds. When members of an LLC do not keep their own money separate from their business funds, they risk losing protection from legal liability. In the view of the courts, a business owner who does not treat their business as a separate entity does not qualify for limited liability protection.
- Sharing assets. Owners of LLCs who own more than one business need to keep separate financial records and lists of assets for each business. For example, if they list an expensive piece of equipment as an asset for one business, they cannot list the same equipment on their other business’s Schedule C.
- Illegal activities. If a corporation is used as a vehicle to defraud creditors, shareholders, or other third parties, a court may disregard the corporate form and hold the individuals responsible for the corporation’s actions. This can occur when the corporation is used to conceal illegal activities or to evade legal obligations.
- Lack of corporate formalities or recordkeeping. Corporations must follow certain formalities such as holding regular meetings and tracking finances. They also must keep a clear separation between the corporation and its owners.
- Undercapitalization. The courts consider whether a business is undercapitalized when a creditor or other litigator asks for lifting of the corporate veil. The court wants to know whether the business has enough money to run. If the court decides the LLC or other business entity is undercapitalized, it is more likely to pierce the corporate veil.
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How to Avoid Piercing of the Corporate Veil and Personal Legal Liability
If you ever face piercing the corporate veil, you will have a better chance of convincing a court you keep your business and personal assets separate by adhering to best practices:
- Follow formalities for your business structure. Corporations need to have annual meetings, file reports, and more. LLCs and LLPs need to file reports to the state, have operating agreements, and keep records of votes on big decisions.
- Save business documents for at least seven years. When you do this, you can prove you run your business following the law.
- Have separate business and personal accounts at the bank and for other accounts.
- Capitalize your business to the extent you can always pay your bills, employees, and contractors.
- Use your business name on everything including contracts, signage, business cards, and other official documents.
Corporate lawyers have advice specific for maintaining the veil for different industries and fields. Whether you are starting a business or tweaking an existing corporate structure, a conversation with an experienced corporate attorney is a valuable use of your time. Swiecicki and Muskett, LLC, advises business owners and corporate leaders based on decades of legal experience. Contact us today if you have any questions about piercing the corporate veil!