What Business Owners Need to Know About Piercing the Corporate Veil
In 2014, a Massachusetts appeals court found a sole member (owner) of an LLC personally liable for damages in a breach of contract lawsuit. The appeals court summary stated the
... the trial court pierced [the company's] corporate veil and found [the defendant] personally liable..." for the damages. The sole reason for this piercing of the corporate veil was because "corporate records did not exist or were not properly kept.
In most other liability situations, the owner of an LLC, corporation, or S corporation would not be charged personally. So what's the big deal about "piercing the corporate veil?"
Corporate Shield or Corporate Veil
The corporate shield or corporate veil is a term used to describe the separation of a corporation from its owners. As a separate entity, a corporation (including an S corporation) or limited liability company (LLC) is set up to "shield" the owners of the corporation (or members of the LLC) from personal liability for the debts or negligence of the business.
Piercing the Corporate Veil
The phrase piercing the corporate veil is used to describe the action of a court to hold corporate shareholders and LLC owners personally liable for the debts and liabilities of a corporation.
Corporations are separate entities from their shareholders, and in normal circumstances, if a corporation is sued, the individual shareholders and officers cannot be brought into the lawsuit. But there are cases in which the corporation's officers and shareholders could be sued for negligence or for debts; the action of bringing in these shareholders to be sued is called "piercing the corporate veil" or "lifting the corporate veil."
In the same way as corporate shareholders, the owners of a limited liability company (LLC), called "members," may also be sued personally for business debts and actions.
When Can Shareholders or LLC Members Be Sued Personally
Two instances in which the corporate veil might be pierced by a court, allowing shareholders to be sued:
- In the case of fraud, in which the corporation was found to be a sham that was set up for the purpose of carrying on fraudulent deals or for fraudulent purposes.
- In the case of egregious and willful activity by corporate shareholders or officers which put corporate gain over the public good.
The concept of the corporate veil is important to the concept of limited liability. In general, if the corporation or LLC is considered completely separate from the individuals who own and manage the business, those owners/managers cannot be held responsible for the company's actions. The company and individuals are separate.
If the individuals act in a way that dissolves (or appears to dissolve) this separation, the "corporate veil" between the company and the individuals has been "pierced" and now the actions of the individuals are no longer separately considered. In this case, one action by shareholders or LLC members can cause other actions to be considered in weighing liability.
Some of the most common actions which pierce the corporate veil are:
- Co-mingling funds (that is, not keeping business and personal funds separate)
- Diverting business assets for personal use without proper documentation (in the case of a loan to a shareholder or offer, for example)
- Failing to keep corporate (or LLC) records
- Officers or directors not functioning in their business capacities
The corporate veil may be pierced is in cases in which a corporate or LLC officer or owner may be liable for debts of the business. For example:
- For payment of payroll taxes, including federal and state withholding and FICA taxes.
- For payments made with personal or business credit cards (according to the terms of the credit card agreement)
- For documents (contracts or loans, for example) signed by the owner personally and not signed by the corporation
- If an owner gives a personal guarantee for a loan or uses personal collateral (like the owner's home) for a loan.
The ability of a business owner to use the protection of the "corporate veil" varies from state to state. Most states uphold the concept of the corporate veil unless the business owner has plainly abused this protection. Texas law, for example, says:
...while shareholders, officers, and directors are generally shielded from personal liability for corporate obligations, when these same people abuse the corporate privilege, courts will disregard the corporate fiction and hold them personally liable.