How to Avoid “Piercing the Corporate Veil"
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One of the main reasons to form a corporation or limited liability company ("LLC") is to shield personal assets from claims against the business. Ordinarily, such claims can only be enforced against assets of the business. An owner's personal liability thus is limited to his or her equity in the company, while personal assets, such as a residence, bank accounts or investments, are shielded from creditors.
Under certain circumstances, however, business creditors may penetrate this shield and go after the owner's personal assets. This is known as “piercing the corporate veil.” Most veil piercing situations arise from a failure to observe legal requirements for maintaining the business, or a failure to clearly separate corporate and personal assets. This article offers some guidelines for setting up and running your business to maximize your personal liability protection.
Observing Corporate Formalities
All states, including Oregon, impose certain requirements on corporations and LLCs. One such requirement is the filing of an annual statement. These statements allow the state to maintain accurate information about corporations and LLCs. Failure to file annual statements and pay the necessary fees in a timely manner can result in the corporation or LLC being administratively dissolved. If a company is administratively dissolved, the owner may lose limited liability protection. Although LLCs have fewer ongoing requirements, corporations are subject to other formalities which include, but are not limited to:
• Holding an initial meeting of directors: After the corporation is formed, it should hold an initial meeting of directors, (also known as an organizational meeting) to adopt bylaws, elect officers, and issue stock.
• Adopting bylaws: After incorporating, the corporation should adopt bylaws. The bylaws outline how the corporation will be operated and are one of the most important corporate documents.
• Conducting business on behalf of the corporation: Officers and directors must hold themselves out as representatives of the business. For example, officers and directors should sign documents on behalf of the entity, and not in their individual capacity.
• Holding annual meetings: A corporation should hold annual meetings of directors and shareholders and should keep minutes of these meetings with the corporate records. Likewise, if items of business are determined by unanimous consent in lieu of holding a meeting, which is popular with many closely-held corporations, the unanimous consent documents should be kept with the corporate records.
• Documenting corporate activity: In addition to maintaining minutes of all director and shareholder meetings, corporations should keep a ledger reflecting all stock shares issued to shareholders, and the contributed amount each share represents. Corporations also should keep contracts to which it is a party, including real property purchase and sale agreements, leases for real property or personal property, and major business contracts.
• Documenting corporate finances: Corporations should keep records of all disbursements, payments received, invoices issued and invoices received. Corporations also should keep balance sheets and profit and loss statements for each year. Additionally, corporations should document any loans taken by the business, along with the repayment terms.
Segregating Business and Personal Finances
A corporation is a legal entity that exists separately from its owners, who have a duty to maintain that separation. Failure to do so risks a claim that the corporation or LLC is merely an "alter ego" for the owner, in which case, the owner's personal assets may be exposed to a creditor of the business. Additionally, courts have ruled that the items mentioned may permit a creditor to pierce the corporate veil.
• Commingling assets: The corporation must open and maintain separate bank accounts. Never use corporate funds to pay personal expenses. If it is necessary for owners to contribute additional capital to meet payroll or pay other corporate expenses, document the additional infusion of funds either as a loan which the corporation must repay, or additional equity for the contributing shareholder.
• Illegal, fraudulent or negligent acts: A corporation is an artificial legal entity which can act only through individuals. If a shareholder makes misrepresentations on behalf of the business, he or she may be personally liable for claims against the corporation arising from the misrepresentation.
• Inadequate capitalization: A new business often lacks substantial capital assets. If a corporation is deliberately undercapitalized, the promoters may become liable for claims against the corporation. One alternative to capital infusions is insurance. A comprehensive discussion of insurable claims is beyond the scope of this article, but insurance often can be obtained to protect against personal injury claims, such as a slip and fall on corporate premises. In addition, corporations can obtain Errors and Omissions coverage to protect corporate directors and officers from claims arising from their actions on behalf of the business.
LLC Guidelines
LLCs have fewer formal ongoing requirements than corporations; however, LLCs ordinarily should take many of the same precautions to avoid personal liability for business owners. Common sense guidelines include:
• Holding an organizational meeting: After the LLC is formed, the members or managers should meet to adopt an operating agreement and to issue membership interest to members.
• Adopting an operating agreement: Like a corporation’s bylaws, an LLC's operating agreement governs how the business will be operated.
• Documenting LLC activity: LLCs should document any changes in membership interests and should maintain records of all major business decisions of the LLC, including real estate transactions, contracts, and leases.
• Documenting LLC finances: LLCs should maintain the same financial information outlined above for corporations.
• Holding annual meetings: An LLC should hold annual meetings of its members and document business conducted at those meetings
While no one of these items on its own may be enough to pierce the corporate veil, multiple items could lead to such an outcome. Limiting your personal liability is one of the most important attributes of a corporation or LLC. If you are forming a new corporation or LLC, or if you want to make sure that your existing business is running properly, please contact our closely held business team leader, Randy Duncan, at 503-417-5490 and we will be glad to assist you.
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