Piercing the corporate veil is a very mystic-sounding term, but it is quite a technical thing once you get into it. It is a term that can only be applied to corporations and LLCs; there is no corporate veil in partnerships.
When the corporate veil is pierced, laws are likely to be violated, and legal action may need to be taken. Most companies are set up on a state level, so when corporate veil-piercing litigation occurs, it usually does so in the state court. Only when federal tax laws are violated can they be heard in federal court.
The Meaning of Piercing the Corporate Veil
The corporate veil, sometimes called the corporate shield, describes the legal separation of a business and its owners. The purpose of doing business as a corporation or an LLC is to shield its owners from personal liability for the business’s debts, negligence, or mismanagement.
The corporate veil is meant to keep the business owner or owners completely separate from the business itself. (It should be noted here that business owners of sole proprietorships have no liability protection as the owner and business are one.) This separation does not stand in all situations.
If the corporate veil has been pierced, then there is no liability protection, and dispute lawyers may be needed to navigate the now-muddied corporate waters.
When to Sue Business Owners
There are times when a business owner can be sued personally and separately from a business. Some of the reasons business owners are not protected from liability include the presence of fraud or other wrongdoing.
Likewise, when subsidiary companies are not kept separate from one another, and when owners and shareholders are not kept separate, owners can be held liable. Perhaps one of the most common reasons business owners are personally sued is due to bad record keeping.
Not following corporate formalities can create a lot of confusion and oftentimes leads to the mismanagement of the business. All of these scenarios can be viewed as piercing the corporate veil and may result in litigation.
Avoiding Piercing the Veil
The best way to avoid piercing the corporate veil is to treat yourself and your business completely separately. Do not use personal funds or make personal guarantees. Keep clear and timely records. If there is a board of directors, officers or shareholders, consider having contracts that include a conflict of interest clause.
And most of all, always have an experienced attorney go over all signed documents as well as the connections between owners, directors, officers, shareholders, and the business and business activities.
Once the corporate veil has been pierced, owners, officers, and shareholders could be found liable for the negligence or debts of the business. Using personal guarantees like using a personal residence as collateral and signing documents as an owner instead of the business are just some common ways the corporate veil can be pierced.
When running a corporation or LLC, it is important to make these distinctions between personal and business in order to make use of the liability protections your business offers.