Business entities can be great tools to operate business, to own/manage assets and to attain a level of asset protection and personal liability protection. However, just creating an entity is not enough. There are ongoing formalities and requirements that must be met when using a business entity. When the formalities and requirements of the entity are not respected, the liability protection that the entity provides is potentially at risk. This is known as “piercing the corporate veil.”
“Piercing the corporate veil” is the term describing a legal action pursued against a company that ultimately leads to personal liability of the owners because the formal separate entity structure is disregarded. This personal liability exposes the owner’s personal investments, real property, personal property, etc., to that of the entity’s problems.
Proper business entity maintenance is a requirement to help avoid these potential problems.
Here are some important factors to keep in mind:
Avoid “co-mingling” of assets - Entity owners should avoid commingling funds and must treat assets of the business separate from personal assets. This may arise when the owners create a separate entity (corporation or LLC, for example) but continue to operate out of personal checking accounts, fail to recognize corporate formalities, or use the company’s assets as if they were personal assets.
Keep separate identities for entities under one umbrella entity - This involves a scenario where there are multiple companies acting under the umbrella of one company (parent company, for example). The parent company must keep each subsidiary separate and maintain its own identity. Problems occur when the parent company operates and controls the subsidiary, provides all of the financing for the subsidiary, uses the same officers, address and corporate information, etc. Remember to keep everything separate - bank accounts, contracts, etc.
Make sure to adequately capitalize the company - Courts will look to the assets of the company to determine if the company’s level of assets available to creditors is fair. Business owners should ensure that, at its inception, the company has its own bank account with an adequate amount of money and/or assets to account for business operations.
Failure to follow corporate formalities - Based on the type of business created, whether it be a corporation, LLC, or otherwise, the owners should be aware of the formalities that they must adhere to. This depends on the entity structure, such as properly updating by-laws, maintaining stock or membership ledgers, holding initial and annual meetings of directors/managers and officers, and maintaining status with a state’s filing requirements. Further, the business activities should be documented and records should be adequately kept and stored.
Please watch what you are doing when working with a separate entity. Ongoing maintenance must be done, especially if you are hoping to protect yourself personally from business entity liability. From the creation of the business to everyday business decisions, owners, officers and shareholders should be mindful of the separate corporate structure and act in a manner that maintains that distinctiveness.