When a business owner forms a limited liability company or a corporation, they expect the entity to protect them from their business’s liabilities. But sometimes the company doesn’t protect its owners. As I discussed in Your LLC Won’t Protect You from Yourself, business owners are always liable for their own negligence and other actions. Piercing the corporate veil is another situation where business owners can be held responsible for their companies’ obligations.
What is piercing the veil?
Piercing the veil is a doctrine that allows courts to disregard a corporation or limited liability company and hold the company’s owners liable for the company’s obligations.
This sounds ominous, and it’s a big deal. But in most cases, it’s not difficult to protect yourself and keep the liability shield of your LLC or corporation if you follow some simple practices that I discuss below.
How does piercing the veil work?
When a plaintiff in a lawsuit wants to hold a company’s owners liable for the company’s obligations, they can ask the court to disregard the protection that the company would normally provide.
For example, someone might slip and fall in a store and be seriously injured. Or a company’s vendor might sue in order to get paid for outstanding invoices. In either case, if the company doesn’t have enough assets to satisfy a judgment, the plaintiff will want to hold the company’s owners responsible.
When can a plaintiff pierce the veil?
In order to prevail on a veil-piercing claim in Missouri, a plaintiff must prove that a company’s owners (1) dominated the company in a way that disregards the company’s separate legal existence, (2) used the company to commit fraud or some other wrong, and (3) thereby harmed the plaintiff.
Obviously, all controlling shareholders and LLC members control their companies, because they have final say on all the company’s decisions and actions. But that kind of normal control isn’t enough to trigger veil-piercing. Veil-piercing requires the kind of control that shows that the owners didn’t treat their company as if it were a separate entity from themselves. It also requires that the control be used by the owners to commit fraud or for some other improper purpose or in reckless disregard for the rights of others.
Collet v. American National Stores, Inc., 708 S.W.2d 273 (Mo. Ct. App. 1986), is the leading case for piercing the corporate veil in Missouri. In Collet, the Missouri Court of appeals listed a number of factors that a court can consider when deciding whether to pierce the corporate veil. These factors include:
- The parent corporation owns all or most of the capital stock of the subsidiary.
- The parent and subsidiary corporations have common directors or officers.
- The parent corporation finances the subsidiary.
- The parent corporation subscribes to all of the capital stock of the subsidiary or otherwise causes its incorporation.
- The subsidiary has grossly inadequate capital.
- The parent corporation pays the salaries and other expenses or losses of the subsidiary.
- The subsidiary has substantially no business except with the parent corporation or no assets except those conveyed to it by the parent corporation.
- In the papers of the parent corporation or in the statements of its officers, the subsidiary is described as a department or division of the parent corporation, or its business or financial responsibility is referred to as the parent corporation’s own.
- The parent corporation uses the property of the subsidiary as its own.
- The directors or executives of the subsidiary do not act independently in the interest of the subsidiary but take their orders from the parent corporation in the latter’s interest.
- The formal legal requirements of the subsidiary are not observed.
You might have noticed that these factors refer only to corporations and that they refer to a parent corporation-subsidiary corporation relationship. But courts also use these factors in the context of non-corporate shareholders and limited liability companies.
Also, there are two principal theories that are often described as piercing the veil, namely that the company is basically the altar ego of its owners and that the company is acting as the agent of its owners. This post doesn’t discuss the agency theory, but see Blanks v. Fluor Corporation, 450 S.W.3d 308 (Mo. Ct. App. 2014), for an excellent discussion of that theory and the history of the piercing the veil doctrine in Missouri.
Tips for protecting yourself
Things every business should do
Regardless of whether your business is a corporation or an LLC, every business owner should follow these practices:
- Avoid paying personal debts with company funds.
- Adequately capitalize the company and keep it solvent.
- Make sure you have adequate liability insurance to cover potential risks.
- Observe state filing requirements, which include filing articles of incorporation or articles of organization, and possibly annual reports, and pay required fees and taxes.
- Keep good accounting records of funds contributed or loaned to the company by its owners.
- Maintain business bank accounts separate from personal accounts.
- Conduct business only in the name of the company, and sign contracts correctly.
- Keep all records required by your state’s corporate or LLC statute.
- Make sure all transactions between the company and its owners are at arm’s length, including loans to and from the company.
The overarching theme is to treat your company as if it were a separate legal person from yourself. Don’t treat its money as if it were your own. All funds going into and out of the company should be correctly accounted for.
Corporation and LLC formalities
If your business is a corporation, it’s important that you observe the formalities of corporate law. If your business is an LLC, it’s usually not as critical, although the importance of formalities varies from state to state. Here are things you should do:
- Hold an initial meeting of the board of directors (if a corporation).
- Adopt bylaws (if a corporation) or a written operating agreement (if an LLC) and follow its requirements.
- Hold annual meetings of shareholders and directors either in person or through a written consent (if a corporation).
- Keep minutes of shareholder and board of directors meetings and actions (if a corporation) or of the meetings and actions of managers and members (if an LLC).
- Keep a record of stock or membership interest issuances and transfers.
The possibility of having a court disregard your company and hold you responsible for your company’s legal obligations can be a scary thought. But you can protect yourself by following a few best practices. Most of all, always think of your company as a separate legal person.