When you’re opening a new business, one concept you may run across is “piercing the corporate veil.” But, what is a corporate veil? And, what does it mean to pierce it?
One of the most significant advantages of creating a corporation or limited liability company (LLC) is to limit your liability, shield your personal assets from your business liabilities. That shield is known as the “corporate veil.”
Piercing the corporate veil means that something happened to cause you to lose this shield, and comes up most often during business litigation.
What Is The Corporate Veil?
The corporate veil is a legal concept. It is a kind of legal wall that separates your personal assets and liabilities from your business assets and liabilities. It is One of the most significant advantages of creating a corporation or limited liability company (LLC).
Classically, the concept of the corporate veil was created to protect shareholders from being held personally liable for things that the business did. It was created to make it easier and less risky to invest in businesses.
If you are a shareholder in a business and that business fails, the creditors of the business cannot come after you personally to pay those debts.
Often, people think of business creditors as being unpaid vendors and banks where the business defaulted on a loan. However, business creditors also include anyone the business owes money to. For example, if a company created a faulty product, and customers sue them, and those customers obtain a judgment, they become creditors of the business. Or, if the company is found top be in breach of contract, then, depending on the judgement, the other party to the contract, also, becomes a creditor.
Typically, the concept of the corporate veil would protect the shareholders of that business from having to pay a judgment out of their personal assets. If the company lacks sufficient resources to pay the debt, the creditors cannot force a shareholder to turnover personal assets to satisfy the judgment.
This concept has also been extended to members of LLCs. While most of the language in the law discusses shareholders, the same protections apply to members of LLCs.
However, sole proprietors and partnerships operating without a legal corporate structure cannot benefit from the corporate veil. The personal assets of these business owners are vulnerable to business creditors.
Moreover, some business owners trying to save money may have used an online incorporation service, an accountant or paralegal to form the business entity. Those business owners could also find their personal assets under pressure by creditors if the legal business entity was not fully or properly formed.
What Happens When the Corporate Veil is Pierced?
The only way the corporate veil can be pierced is if a court makes a legal ruling that the owners of the business acted in a way that justifies the corporate veil being ignored.
If a court pierces the corporate veil, the personal assets of some or all of the shareholders or members may be vulnerable to attack from creditors.
Before a creditor can collect from individual shareholders or LLC members, they must proove:
- A creditor must prove the business is liable to them for some legal reason.
- A creditor must prove that the business owners or shareholders acted in a way that justifies the piercing of the corporate veil.
- A creditor must establish that an individual is a shareholder and that the corporate veil should be pierced with respect to their assets.
Once the corporate veil has been pierced, and a creditor has established they are owed money by one or more shareholders, they can place liens against the personal assets and take other legal collection actions.
Why Might The Corporate Veil Be Pierced?
Courts are reluctant to pierce the corporate veil. Any creditor who wishes to go after the personal assets of the shareholders has to meet the burden of proof that the shareholders acted inappropriately in one or more specific ways.
The simple fact that a business has accumulated debts that it cannot pay is not enough for the piercing of the corporate veil.
However, if one or more of the shareholders have signed a personal guarantee on a loan or merchant account, they have voluntarily agreed to forego the protection of the corporate veil as to that creditor.
If a court finds that there was no real separation between the business and the shareholders and that the business acted in a fraudulent or otherwise inappropriate way, the corporate veil may be pierced.
When shareholders commingle personal and business assets, fail to observe corporate formalities, and have poor corporate governance practices, they become more vulnerable to attacks on the corporate veil.
Florida Law and the Corporate Veil
In the United States, each state has its own set of laws that govern corporations, including what it takes to pierce the corporate veil.
Florida requires that any creditor seeking to pierce the corporate veil first successfully prove the corporation in question is liable for a specific debt.
Once that liability has been established, the creditor then has the burden of proof to show three things before the court will allow the corporate veil to be pierced:
- There was no meaningful separation between the corporation and the shareholders.
- There was inappropriate conduct in the use of the corporation by the shareholders.
- The damages or loss suffered by the creditor was caused by the inappropriate conduct.
If a creditor can only prove one or two of these elements, the court will not pierce the corporate veil. The simple fact that a company is a wholly-owned subsidiary, or that a small number of shareholders control the management of the corporation is not enough to justify the piercing of the corporate veil. Even a failure to observe statutory corporate formalities like holding annual meetings is not enough in and of itself for the court to pierce the corporate veil.
The creditor has a heavy burden to meet if they want to go after the personal assets of shareholders.
Because lawmakers and the courts recognize that the corporate veil is fundamental to the healthy flow of commerce, they have made it difficult to successfully pierce that veil.
However, it is not impossible. Business owners need to be cautious in the way they conduct financial affairs, corporate formalities, and corporate governance practices if they want to ensure that they can enjoy the full protections of the corporate veil in the face of litigation from creditors.
Work with a solid business attorney who understands the idiosyncrasies involved with business formation