As a business owner, one of the key considerations in selecting a specific business entity is how much liability you are willing to take on. Corporations are viewed as individuals under liability laws, which generally means that you, the business owner, are not personally liable for the debts or legal obligations of your business.
Nonetheless, exceptions apply. In some situations, a business owner can be held personally liable for business debts or other obligations that would ordinarily fall within the business’ responsibilities. Through a process known in legalese as “piercing the corporate veil,” a creditor or individual may sue the business owner personally for the transgressions of the business. This would expose your personal assets, like your home, your vehicle, and your bank accounts to a civil judgment.
So, how is the corporate veil pierced and what can you do to protect yourself and your business? Here, we discuss the basics you need to know about the liability shield known as the corporate veil and how to strengthen it to protect yourself and your assets from personal liability.
What is the “corporate veil?”
The “corporate veil” is a term used to refer to the liability shield established when a corporate entity is created. By operating as a corporation rather than a sole proprietorship, the business owner is generally shielded from personal liability for actions or debts of the business. Should a creditor or individual harmed by the business file suit for the debt or injury, only the business and business assets would be at risk. The business owner and his or her personal assets are protected from liability.
In other words, the corporate veil separates the business and the business owner, ensuring both are treated as separate legal entities.
How is the corporate veil pierced?
If the court determines there is an insufficient separation between the business and business owner for the two entities to be treated independently, a creditor or individual can file a legal action to “pierce” the corporate veil, that is, sue the business owner personally for one of the business’ transgressions. Upon piercing the corporate veil, the legal protections previously afforded to the business owner through the creation of the entity disappears, exposing his or her personal property to a civil judgment.
To pierce the corporate veil, the creditor or injured party must prove that the business was not functioning as a separate entity and that the lines between the business and its owner were blurred. This is often called the “alter ego” theory; that is, the business was operating as an alter ego of the business owner himself. In these cases, creditors can attempt to hold the business owner responsible for the debt or injury. In North Carolina, the creditor or injured party seeking to hold the business owner liable by piercing the corporate veil must prove that the business owner had so much control over the business that the business did not have a “separate mind, will, or existence of its own.”
As in most states, North Carolina law generally does not favor the practice of piercing the corporate veil and trumping the liability protection afforded to business owners. Therefore, the individual seeking to hold the business owner personally liable must allege and prove serious misconduct to overcome the liability protection.
Courts examine several factors in discerning whether a company truly has established an independent existence from its owners. Some of these factors include:
- Whether the company was adequately capitalized;
- Whether the company’s directors, shareholders, officers, members, or managers compiled with corporate formalities in running the business;
- Whether the company was solvent;
- Whether the company was fragmented into multiple “shell” entities;
- Whether the individual owner at issue siphoned funds from the company to pay his or her personal expenses or debts; and
- Whether the company maintained proper corporate records.
Can I avoid personal liability?
The simplest way to maintain the protection of your liability shield is to make sure that your business operates in a fair, honest, and accurate manner following applicable rules and complying with business standards.
Your attorney can advise you on how to do so. However, generally, business owners seeking to maintain substantial liability protection tend to do the following:
- They do not commingle finances. They keep business accounts and personal accounts separate. They do not use corporate accounts or other business funds to pay personal expenses.
- They follow the rules. Corporations must create and comply with bylaws, pay corporate taxes, and satisfy meeting requirements. There are strict formalities that corporations must follow, and LLCs are advised to comply with the same requirements.
- They maintain proper records. Business decisions and meetings should be documented, and the records should be kept for at least seven years. Businesses that maintain a strong liability shield ensure minutes are recorded for significant meetings such as board meetings and shareholder meetings. All their records are accurate, consistent, and stored in a secure location.
- The adequately fund the business. You need money to start a business. Whether you use your own money, have investors, or obtain a business loan, you must have adequate funds to purchase the equipment and inventory you need to open the business and maintain operations.
- They properly convey their business status. Whether you are a corporation or LLC, make sure that your business status is apparent, and you do not present yourself as a sole proprietor. Invoices, contracts, business cards, and other business-related documents should address the business as an entity separate and apart from you and your assets.
An experienced business attorney can assist you with structuring your business and managing business transactions to protect you from personal liability. Whether you need assistance getting your business started or have questions about your liability based on current practices, our team has the knowledge and advice you need to operate a successful business with a strong veil to shield you from personal liability.