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As an attorney and consultant, there are few axioms that cross industry lines. One is, “Don’t mix business with pleasure.” For some of you, the reason why is obvious. For others, you’re why HR departments exist. But today’s focus is not about fraternization at your place of employment. It’s about smart corporate practices to keep your personal and professional business separate. To kick this discussion off, we’re going to talk about company structure.
Many business owners choose to form a corporation or limited liability company (LLC) because of the limited liability these business structures offer. By creating a corporation or LLC, owners generally won't be held responsible for their business's debts and obligations. But sometimes courts will hold an LLC or corporation's owners, members, and shareholders personally liable for business debts. When a court allows a plaintiff (person(s) filing suit against the corporation) to reach the owners’ personal assets, it is referred to as "piercing the corporate veil." When the corporate veil is pierced and a judgment is entered, to satisfy the debt, creditors can go after the owners' personal assets, including:
When Courts Will Pierce the Corporate Veil
States differ on when the corporate veil should be pierced*. In general, it's usually difficult to do. Numerous courts engage in some variation of a two-part test when deciding whether to pierce the corporate veil.
1. Is the Company Truly a Separate Entity From Its Owners?
If the owners fail to create and maintain a formal legal separation between their business and their personal financial affairs, a court could find that the owners are personally operating the business as if the company doesn’t exist. For starters, owners should create an operating agreement. An operating agreement is a key document used by limited liability companies (LLCs) that outlines the business’ financial and functional decisions, including rules, regulations, and provisions. The purpose of the document is to govern the internal operations of the business in a way that suits the specific needs of the business owners.
It may be obvious to most business owners and officers to separate your personal and business funds. However, one of the most egregious examples of mixing business and pleasure is communicating private matters on business channels. There generally isn’t a prohibition against emailing your partner/spouse from your work account about your kid’s soccer schedule. However, understand that doing so could make those personal communications subject to discovery*, should there ever be a lawsuit or investigation where that person’s communications are of interest. They may never make it to the “court file” but to determine if they should, someone, or a team of someones, is going to have to read them. So, don’t.
*discovery is the pre-trial process where the parties involved gather information
2. Did the Owners or Decision Makers Engage in Fraud or Wrongful Conduct?
Engaging in fraud or wrongful conduct can expose you to having the corporate veil pierced. For example, suppose an officer of the company misrepresents the company’s profits to take out a loan, or raise capital. In this instance, a judge could rule that the corporate officer committed financial fraud and that the limited liability protection shouldn’t apply.
There are other factors courts consider in piercing the corporate veil such as:
The key takeaways should be to create an operating agreement about how you operate and manage the company, keep personal and business separate and don’t commit fraud or wrongful conduct. If you have any questions about drafting an operating agreement or to create systems and rules to keep you far away from the prospect of having the corporate veil pierced, please schedule your free consultation today to learn how we can help.
