If you have an LLC or corporation, you are likely concerned about protecting yourself from liability. After all, the purpose of these entities is to shield their owners from being personally liable for company debts.
Unfortunately, while your LLC or corporation can help you avoid personal liability in most circumstances, there are situations where creditors or claimants of your company are able to claim personal liability against its owners or managers.
One example is what is known as piercing the corporate veil of the company. There are other types of claims that creditors or claimants can attempt to assert to hold owners or managers personally liable for claims against the company. But there are steps you can take to protect yourself and your business. A commercial litigation attorney at Miller Law can provide you with valuable advice about your options.
What Liability Protection Does an LLC or Corporation Give Me?
When you set up a corporation, LLC, or limited partnership, you create a distinct legal entity with its own assets, obligations, and liabilities. This is different from a sole proprietorship or partnership where you operate your business under your own name.
When you have a distinct corporate entity, like an LLC, the only personal assets you risk are those that you invest in the business. If your LLC fails and can’t pay its debts, creditors can only go after the assets owned by the LLC. They won’t be able to go after your home, personal bank account, or other assets. This shield is known as the “corporate veil.”
However, there is an exception to this protection—in limited circumstances, your LLC’s creditors may be able to go after your personal assets if a court permits them to pierce the corporate veil.
What Is Piercing the LLC Veil?
Corporate veil piercing occurs when the court allows a plaintiff to pursue legal action directly against the owners of an LLC or corporation. This is an extreme remedy that courts allow only in specific circumstances.
Piercing an LLC corporate veil occurs most often with small, closely held companies. This is because small companies run by one or two people are less likely to understand or follow the important formalities of operating a distinct entity. As a result, they tend to compromise their LLC’s separate character by mingling their personal and corporate assets.
Another situation where LLC piercing is likely to occur is when you have multiple business entities managing different parts of your business or performing different functions. If you allow these companies to overlap with each other by mingling their assets or resources, you could be vulnerable to veil piercing.
When Can You Pierce the Corporate Veil?
Under Michigan law, a plaintiff must establish three elements to convince a court to pierce the corporate veil:
- That the business was merely an instrumentality of another individual or entity;
- That the business was used to perpetrate a fraud or wrong; and
- That the plaintiff will suffer an unjust loss as a result of the business’s actions if the court does not allow piercing of the veil.
We discuss each of these elements in turn.
Business Is a Mere Instrumentality
The first element examines whether the business was truly independent or whether it was merely an instrumentality of the owners. This may also be called unity of interest or the alter ego doctrine.
An LLC is meant to be a shield against personal liability. But to be treated as such when it comes to liability, the LLC has to truly be a distinct entity from its owners. If someone asks the court to pierce the corporate veil, the court will look at factors such as:
- Whether the owners used the LLC’s funds for personal purposes;
- Whether the LLC was undercapitalized;
- Whether the owners have comingled personal and LLC funds; and
- Whether the LLC follows corporate formalities such as voting or holding board meetings.
If the owner of the LLC is another corporation or LLC, the court also may consider whether those entities have the same employees or offices.
Used to Perpetrate a Fraud or Wrong
To pierce the LLC corporate veil, it is not enough to simply show a unity of interest. A plaintiff also has to show that the owners used the LLC to commit a fraud or a wrong.
Fraudulent action that could justify piercing the corporate veil might include:
- Providing false documentation of your business’s assets and liabilities to get a loan;
- Moving money from business to personal accounts to avoid creditors; or
- Entering into a contract that the LLC doesn’t have the means to fulfill.
This is just a sample of situations that could justify piercing the corporate veil. Fraud can involve any actions where you mislead someone for the purpose of benefiting yourself.
Finally, the plaintiff has to show that they would suffer an unjust loss as a result of the LLC’s actions if piercing the LLC veil is not permitted.
For example, imagine that LLC members moved all the LLC’s money out of its accounts and into the members’ personal accounts. As a result, the LLC is unable to meet its financial obligations and defaults on a loan. The lender attempts to collect a judgment but finds that the LLC has no assets. Since the members undercapitalized the LLC and siphoned funds to avoid liability, the lender may argue that the veil should be pierced to prevent them from suffering an unjust loss.
How Can You Prevent Piercing the Corporate Veil of Your LLC?
One of the most important steps you can take to protect your LLC from corporate veil piercing is to observe important formalities in your business. Be sure to:
- Keep the LLC’s accounts separate from all other accounts;
- Keep a tight accounting of how the LLC has used funds and assets;
- Don’t use LLC funds for personal expenses;
- Hold regular board meetings and comply with formalities in your operating agreement;
- Take meeting minutes and keep records;
- Make sure to formally document any loans between the company and its owners;
- Make sure to keep enough capital in the LLC accounts to support your business operations; and
- Keep multiple business entities distinct from one another.
It’s easy to let these types of formalities slide in a small business. But doing so can be costly and may deprive you of the liability protection an LLC should give you.
How Can a Lawyer Help?
The sophisticated business law attorneys at the Miller Law Firm have spent nearly 25 years serving businesses in Michigan and around the country. They represent all types of businesses from sole proprietorships to nonprofits to Fortune 500 companies.
The Miller Law Firm can help you organize your business, advise you in operating it, and protect it from harm. If you have questions about piercing the corporate veil of an LLC or any other legal question affecting your business, don’t hesitate to contact us. Call or message us online today to set up your initial consultation.