A primary benefit of forming a legal entity such as a corporation or limited liability company is that, as a general rule, the individual owners, officers and employees are shielded by the company’s legal structure from personal liability for the company’s debts. This shield is commonly referred to as the “corporate veil.”
Unfortunately, the corporate veil can be pierced in the right circumstances. For example, there are statutes that hold officers and employees personally liable for a company’s failure to pay withholding or sales taxes. Other statutes provide that company officers may be personally liable for a company’s failure to comply with environmental laws governing hazardous waste disposal. In addition to these statutes, courts have imposed personal liability on company owners in a variety of situations.
While the laws vary from state to state, a piercing of the corporate veil may occur if one or more of the following exists:
- inadequate capitalization of the company
- failure to follow corporate formalities
- failure to maintain company records
- commingling company funds with owners or affiliated entities
- fraud, wrongdoing, or injustice to third parties
There are steps business owners can take to mitigate the risk of personal liability for a company’s obligations.
For example, hold shareholder and director meetings as called for by the corporation’s Bylaws. In addition, obtain approval for non-routine company actions by the directors if a corporation or by the Members or appointed Managers if a limited liability company. Non-routine actions might include, for example, an office or equipment lease or a long-term contract with a customer or vendor. Keep documentation of those approvals in the company’s minute book.
Maintaining separateness between business and personal bank accounts is critical. Avoid casual exchanges of funds between personal and company bank accounts and formally document owner loans and capital contributions if the company needs funds.
Oftentimes business owners are so focused on running their companies that they overlook these formalities and blur the line between their business and personal affairs. Consider conducting a periodic audit of your company’s records and operations to identify and correct any deficiencies that might otherwise result in you being held personally liable for your company’s obligations.