Managing Your Business

"Piercing the Corporate Veil": How to guard limited liability

Many would-be business owners hesitate to make their dreams a reality because they fear that their personal assets could be taken to satisfy unpaid business debts. A market downturn, a family emergency, a medical issue… these could all derail a business, and, if proper precautions are not taken, cause personal financial ruin.

There is a solution.

Personal asset protection is considered by many business owners to be the most important perk offered by filing for a formal business structure. This means that, in most circumstances, your personal assets are safe if your business is sued. However, successfully filing for incorporation (or forming as another business type that offers limited liability) does not automatically ensure your personal assets are not subject to seizure in a court of law.

In the event that a creditor sues your company for money or damages and requests that the court “pierce the veil” in their ruling, they are asking the judge to invalidate the usual separation between company debts and personal debts. If the judge rules in the favor of your creditor, the protections offered by your business structure will be null and void. The court could then take your personal assets to satisfy your businesses debts.

Courts will not likely rule to pierce your corporate veil if your business is well-run and operating in the spirit of a limited liability corporation. There are certain ongoing requirements and formalities that must be observed to ensure that your personal assets remain protected.

Five ways to ensure your personal assets are safe

Even the most experienced business owners cannot predict when or if their company may fail, or foresee sudden legal challenges. As a result, maintaining your company’s limited liability status should be taken very seriously to avoid your being personally held liable for the company’s debts.  

Here are the five most important steps you can take to ensure that your company avoids a court ruling that pierces your corporate veil:

1) Document everything.
The most effective defense to fight a request to pierce your corporate veil is exhaustive evidence of your above-board practices, in the form of paperwork. You should be able to easily and concretely prove that your organization has not been violating the spirit of limited liability.  If the court cannot determine that your business has been consistently operating in compliance with the appropriate accounting and financial regulations, you will be in danger of a ruling based on other evidence. Without clear, verifiable documentation of both your operations and major cash transactions, your personal asset protection is at significant risk.

2) Pay close attention to your cash flow.
Obviously, the easiest way to ensure that you will not be held personally liable to pay your business’s debts is to make sure that your company has enough cash on hand to pay all expenses.  However, this advice does not always protect you in the case of an unexpected legal ruling.  If your company does run low on cash, it is not legal to move any personal or outside funds into the business without following all relevant financing procedures, which includes thorough and proper documentation.  

3) Conduct all business on paper.
Ensuring that all of your business’s transactions are properly invoiced, recorded, and conducted through only business accounts is integral in proving that you have operated within the legal confines of your business structure. Making sure that all contracts, billing documents, and paper work prominently displays your company name and corporate status, can also establish a precedent that you have been operating your personal affairs separately from your business’s.  

4) Properly observe all imposed regulations and formal processes.
All formal business structures are required to observe certain formalities to ensure that they are operating in the spirit of their limited liability status.  C corporations typically must hold documented annual shareholder, officer, and manager meetings, file certain sets of regular paper work, and pay special taxes.  LLCs do not have such stringent requirements, but it’s still recommended that you follow these higher standards whenever possible.  In the event of a company’s limited liability coming into question, the court will look at how these mandated processes are followed to see if the company has been operating aboveboard.

5) Keep your personal and business finances separate.
Most piercing the veil rulings are against small business owners who cannot show that company and personal funds have been managed separately. Failing to keep business and personal assets verifiably apart from one another often proves to the court that the business has not been operating as the separate legal entity that it has claimed to be.  

While paying close attention to these five aspects of business operation can go great lengths to protect your company’s limited liability status, it is always best to speak with an attorney or accountant regarding any questions you have regarding corporate and personal liability concerns.  By doing so preemptively, you can create a clearly documented strategy that will help you stay compliant with all regulations. Then rest easy, knowing that your personal finances will be safe in the event of an unforeseen business disaster.

Swyft can help!

Want to talk about protecting your personal assets by filing as an LLC? The experienced representatives her at Swyft are more than happy to help guide you through the process.Contact us today!

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