How to Prevent Piercing the Corporate Veil

January 29, 2020by Brian Walsh

One of the reasons business owners go through the legal formalities to incorporate their enterprise is to avoid risking personal liability for the debts of the business. If a court chooses to pierce the corporate veil, the owners of the business lose all of these protections.

Fortunately, the courts in Florida are reluctant to take the drastic step of piercing the corporate veil. But it does happen.

There are several principles business owners should follow to prevent a court from having any reason to consider piercing the veil.

1. Appearances Matter

One of the first principles that business owners trying to protect their personal assets need to understand is that in the legal system, appearances do matter. The more suspicious any business activity appears the more likely the court will look to find reasons to pierce the corporate veil.

Business owners should be circumspect in their business operations. Companies get into trouble when they look like they are trying to hide evidence of their actions from investigators or the court.

Companies should document business and financial decisions. You will be safer if you have a paper trail that proves you comply with generally accepted business practices.

While it is critical that your business maintains the appropriate levels of confidentiality for proprietary information, it should not be in the practice of destroying records or ordering employees not to document anything.

2. Avoid Co-Mingling

A corporation or limited liability company (LLC) is a separate legal entity from the business owner or owners. This means the company needs its own independent bank account, and that the funds of the business should only be used for legitimate business expenses.

When business owners use corporate accounts for personal expenses, it makes it easier for a court to conclude that the company is simply the alter-ego of the business owner and not a true separate legal entity.

Likewise, the personal accounts of a business owner should not be used to pay business expenses. If you need to take money out of the business, document the draw on the books of the business, and transfer the funds to your personal account before using the money for personal expenses.

If you are going to invest more of your money into your business, document the cash infusion and transfer the money to the correct corporate account. Do not pay business bills from your personal checking account or with your personal credit cards.

Do not co-mingle corporate assets and personal assets.

3. Strictly Follow Corporate Formalities

While the basic paperwork needed to incorporate or to set up an LLC is not lengthy, it is critical that this paperwork is completed correctly. This paperwork includes the foundational documents of the new company.

In addition to making sure the initial paperwork is completed correctly, business owners need to faithfully follow all of the corporate formalities required by the law. This includes having regular shareholder meetings and keeping records of those meetings. It also includes paying any annual fees to renew the corporate charter.

If you want to avoid a court piercing the corporate veil, you need to demonstrate that the business operates as a legitimate corporation, including following all of the technical annual corporate formalities.

4. Maintain Appropriate Capital Levels

We all need money to pay our bills. Your business is no different. You need to make sure your business has sufficient levels of capital to both start and continue operations. If it looks like the business is really a way for you to shelter your money, a court will be more likely to pierce the corporate veil.

The purpose of a business is to earn a profit. While not all businesses succeed, if a court believes the owners are using the company for some other purpose other than generating a profit, piercing the corporate veil becomes a more reasonable remedy. Ensuring appropriate capital levels will protect the corporation and its owners from looking like they are trying to game the legal system.

5. Good Corporate Governance

Companies have rules and procedures beyond what is minimally required by the law. Good corporate governance practices help avoid the appearance of a conflict of interest among the officers and directors of the company. These rules help prevent anyone from using the business as their personal piggy bank, or as a tool to commit some type of fraud.

Being able to show a court that the executives and board members of the company all follow well-drafted corporate governance policies will make it less likely that the court will try and pierce the veil.

6. Arms-Length Transactions

One issue courts look for when deciding whether or not to pierce the corporate veil is if the company engages in arms-length transactions or if there is favoritism shown to some shareholders.

If any owner has a special interest in a transaction because of an ownership interest in the other party, the company needs to observe strict formalities. This includes having the transaction approved by someone other than the owner with the financial interest, having contracts that govern the relationship, and making sure reasonable market rates are being paid.

Arms-length transactions help demonstrate that the company and the owners are separate entities in practice as well as under the law.

Courts are more likely to pierce the corporate veil when it looks like the owners of the company were trying to commit some type of fraud or when the owners fail to maintain any separation between their personal financial matters and those of the company.

The best way to avoid having a court pierce the veil is to follow the law. Strictly observe every corporate formality. Have written policies in place to deal with conflicts of interest. Make sure that the leaders of the company are committed to strong corporate governance. Most importantly, treat the company as the separate legal entity that it is. Do not allow yourself to view yourself as being the same as the business.

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