How to Avoid the Corporate Veil Being Pierced
As a general rule corporations and limited liability companies (LLCs) are separate and distinct from their shareholders and members, which means, the owners are generally not personally liable for the debts and obligations of the business. However, there are instances where courts see fit to pierce the corporate veil, disregarding the company and finding one or more of the owners personally liable.
In New York, the corporate veil may not be pierced unless there are exceptional circumstances, such as a showing that (1) the owner exercised complete domination of the company with respect to the subject transaction; and (2) that such domination was used to commit a fraud or injustice which resulted in an injury to a third party. One such factor courts consider is where the business owners fail to observe corporate formalities. These range from holding annual meetings, to keeping accurate and detailed minutes on the company books, to maintaining necessary officer positions, to failing to properly account for monies paid to or by the owners.
Although New York courts will generally put less emphasis on corporate formalities when it comes to LLCs, as they have fewer formal requirements than corporations, business owners are best advised to adhere to corporate formalities, especially if imposed by their LLCs’ operating agreements. The following is a list of best practices that company owners should follow to decrease the chances that the corporate veil be pierced:
- Adopt bylaws or an operating agreement, as applicable, and make sure they are followed by all directors and officers or members and managers.
- For corporations, hold both an initial and then annual meeting of both directors and shareholders. Minutes of all meetings should be taken and kept safely stored with all other corporate documents. While this is a good practice for LLCs as well, it is generally not necessary unless required under the company’s operating agreement.
- Corporations should formally issue stock to shareholders and LLCs should issue membership interests to members in writing. The names of the shareholders or members and how much ownership they have in the company should be kept current and stored with the rest of the corporate documents.
- Document all other major business actions, including agreements with third parties, and retain them for at least seven years.
- Have separate letterhead and business cards that clearly list the name of the company. Any office space signage should clearly list the name of the company, and not just that of its owner(s).
- Keep the bank accounts of the owners and the company separate.
- Make sure the company is adequately capitalized, whether by requiring owners to make scheduled contributions or by keeping a minimum amount of funds in the company’s bank account. It is a good rule of thumb to keep capital of at least three months’ worth of anticipated costs in the company’s account, to cover overhead expenses, employee salaries, contractor fees, etc. Do not fund the company only when bills need to be paid and never allow the company to have zero assets. Note that every business owner, regardless of the type of business entity, is personally liable if the business doesn’t pay the taxes it withheld from employees’ paychecks. In addition, the ten largest shareholders or members with the largest percentage of ownership interests of the company are personally liable, jointly and severally, for all debts, wages or salaries due and owing to any of company’s laborers, servants or employees other than contractors, for services performed by them for such company.
- Do not personally guarantee the debts of the company.
- Do not put up your property, such as a house or other real estate as security for a business loan.
- Do no sign contracts in your own name. All agreements should be entered into explicitly in the company’s name.
- Do not allow owners to share employees, accountants, or lawyers with the company. If there are common workers or advisers, make sure that they have executed a separate engagement letter with the company and that services provided to the company are paid for out of the company bank account.
- Properly account for monies paid to or by the owners. Do not deposit your personal money into the corporate account unless it is a loan or capital contribution (to purchase additional shares or membership interests) that is formalized in writing and agreed to by all shareholders or members. When you need money, do not simply deduct funds from the corporate account, without following a board meeting approving a dividend or a distribution in accordance the company’s bylaws or operating agreement.
- Company assets should not be used for personal purposes, including corporate credit cards, accounts, office space, phone lines, computers and other corporate assets.
Always consult a lawyer if you operate or plan to incorporate or organize a business as a corporation, partnership or LLC. An attorney can help you protect your personal resources from corporate liability.