How Business Owners can avoid Personal Liability if others attempt to Pierce the Corporate Veil

Generally, owners of corporations and limited liability companies are not personally liable for business liabilities. However, under some situations, courts allow creditors to “pierce the corporate veil,” to access a corporation or LLC owner’s personal assets. It is vital for business owners to know how, when, and why their personal assets may be vulnerable to their business liabilities. The major considerations the court looks to are whether the company is undercapitalized and if the owner is using the company as an alter ego. Take a look at this article on Is New York A Tort State? Before you go through the below pointers on how you can avoid personal liability.

Undercapitalization & Alter Ego

Arizona requires corporations to be adequately capitalized at the time of formation and through the life of the corporation. No exact amount is required, but the purpose is to protect creditors and others with whom the company has liabilities. “Alter Ego” refers to when the owner treats the company as a sole proprietorship, a partnership, or a personal asset rather than as a separate business entity. Accordingly, it is important to take the following steps to avoid piercing of the corporate veil:

Maintain adequate business capitalization from the inception of the company forward.
Engage in the necessary formalities required for the business entity.
Avoid commingling business and personal assets and activity.
Make the corporation or LLC status known to your clients.
Document all business actions.

1. Ensure adequate capitalization from the inception of the company forward.

All corporations, at the time of formation and throughout the life of the corporation, must be properly capitalized to respond to claims and liabilities arising out of the corporation. No exact amount is required. However, the general test of capitalization is at inception. Therefore, the most important time to have your company capitalized is at its inception. Business owners should then continue to keep the company adequately capitalized throughout the company life relative to current and foreseeable liabilities. Doing so will protect others from piercing the corporate veil to access owners’ personal assets.

2. Engage in necessary formalities.

Corporations have formalities that they must follow. Although LLC law is not as stringent, it is also smart for owners of an LLC to follow such formalities. The court views a company that lacks the necessary formalities as a possible indication the owner is using the company as an alter ego. If the court believes that the owner may be using the company as a sole proprietorship, partnership, then the court may treat the company like a sole proprietorship or a partnership, by allowing the corporate veil to be pierced making the owners personally liable. Owners should ensure their company takes part in the following formalities to avoid personal liability:

Corporations:

Create, maintain, and update bylaws.
Issue shares of stock to stock owners.
Maintain a stock transfer ledger.
Hold initial and annual meetings with directors and shareholders.
Keep annual filings, fees, and taxes current with the state of incorporation.

LLCs:

Issue membership certificates to owners.
Keep a membership transfer ledger.
Hold initial and annual meetings of the members and managers.
Keep annual filings, fees, and taxes current with the state of incorporation.

3. Avoid commingling business and personal assets and activity.

Owners should set up a business savings account, business checking account, and business credit cards. They should pay for business expenses with business accounts and personal expenses with personal accounts. Owners should keep their personal assets in their name and the business assets in the name of the business. This will protect business owners against any allegations that they are using the business as an alter ego.

4. Make the corporation or LLC status known to your clients.

Business owners should make the status of the corporation or LLC known to their clients. Business cards and other labels should name the company as a corporation or an LLC. All contracts and documents should be assigned to the business and not the individual owner. Invoices should have the company’s name rather than the owner’s. This will protect against alter ego allegations claiming creditors and clients were unaware the company was a corporation or LLC.

5. Document all business actions.

Business owners should document everything. They should document when they engage in formalities, any evidence that shows they maintained separate accounts for personal and business activities, and any documents showing they maintain adequate business capital. These documents will be the evidence needed to protect the business owner’s personal assets if a creditor attempts to pierce the corporate veil.

Business owners should treat their company as a separate entity, should engage in all the necessary formalities required under corporation law, and should document everything. It is always best to seek out attorneys at the inception of the company and throughout as needed. The Mesa Arizona business attorneys at Gunderson, Denton, and Peterson PC assist clients with these and many other business legal needs.

Written By Brad Denton