Forming an LLC protects your personal assets from liabilities arising in business.
This limited liability coverage is also known as “the corporate veil”.
However, simple mistakes can pierce this veil, putting your personal assets at risk.
Watch this video to learn about the corporate veil, how to protect it, and what it does
not cover.
LLCs are a business structure designed to protect their owners from personal liabilities
for the business’s debts.
Hence the name limited liability company.
This protection is often referred to as the Corporate Veil, and it creates a legal distinction
between a company and its owners.
However, there are situations when a court can pierce this veil, and the owners and members
can be held legally responsible for debts and lawsuits against the company.
An unpaid creditor, for example, can sue the owners to collect a debt incurred by the business.
If the court can prove that the corporate veil has been pierced, by commingling assets,
improper filings, or fraudulent activity, the limited liability protection offered by
an LLC structure is rendered invalid.
In that case, the creditors would be able to collect their debts directly from the personal
assets of the company owners and members.
To preserve the corporate veil, there are several guidelines to follow:
One: Sign Correctly.
It might not seem like a big deal, but how you sign business documents needs to reflect
that the company is separate from you as a person.
Any business dealings and contracts should be carried out in the name of the company,
with the individual signer clarifying that they are signing on behalf of the company,
as an authorized and titled member.
This will demonstrate on an ongoing basis that you are not individually responsible
for the company’s debts.
2: Don’t Commingle Finances.
Failure to establish clear separation between personal and business finances is a common
mistake, particularly among underfunded companies.
Your LLC should have its own bank account and credit card, and engage in its own transactions
separate from the owners.
Owners should not utilize the company’s money for their own individual purposes (for
example, paying home cable bills) without adequately documenting the transaction as
a loan or a draw.
If the company needs additional funds and the owner wishes to contribute, this should
be documented as a capital contribution, with appropriate documentation created at the time
of the transaction.
Always document business expenses- there are many accounting and bookkeeping solutions
available.
3: Follow an Operating Agreement.
An Operating Agreement is an internal document that outlines the ownership and member roles
of the company, and gives your LLC legal credibility.
This is particularly important for single-member LLCs, as you will need to provide evidence
to the court that you have not compromised the distinction between yourself and the entity
known as your company.
For this reason, it is also important to document major decisions and resolutions with a formal
paper trail to demonstrate that you are treating the company’s affairs as separate from your
own.
4: Keep your LLC up to date.
In some states, failure to file an annual report with the state of formation can result
in automatic dissolution of your LLC.
If your LLC is dissolved by the state, the owners of the business no longer have limited
liability protection.
What the Corporate Veil Does Not Cover
Even if you perfectly maintain the separate identity of the company, there are still some
situations where the owners may become liable.
These include:
1: Personal Guarantee Obligations.
Personal Guarantee Obligations.
If an owner signs a personal guarantee of the company’s obligations- when signing
a commercial lease or loan agreement, for example- it is a voluntary waiver of the corporate
veil.
2: Liability for personal acts or carelessness.
There are situations where individual members, although acting on behalf of the company,
have personal liability for their actions.
If personal recklessness or carelessness causes an injury, for example, the individual as
well as the company may be liable for the resulting harm.
3.
Liability for taxes.
Members of limited liability companies are personally liable for their own taxes resulting
from company operations.
They may also be personally liable for certain taxes of the company (for example, certain
state and federal withholdings for employees) if they are “responsible persons” who
controlled the company’s money and ability to pay the company’s debts.
To protect yourself, it is critical to properly account for company transactions and remit
all taxes due to the various taxing authorities by the deadlines.
Corporate Veil
To recap, the corporate veil ensures the limited liability of an LLC.
To preserve it, business owners must sign documents correctly, keep personal and business
finances separate, draft and follow an operating agreement, avoid fraudulent activities, and
keep up to date with annual filings.
A corporate veil does not cover personal guarantee obligations, personal acts or carelessness,
or certain tax liabilities.
To learn more about the corporate veil, LLC formation and maintenance, and research other
small business resources, follow the links below and visit us at howtostartanllc.com