Some business entities, such as LLCs and corporations, offer limited personal liability for the business owners – but this can be removed if the business engages in nefarious deeds. When this occurs, it’s called piercing the corporate veil.

In this article, we explain what this exactly means, the effects that it creates, and provide real-life examples. We also offer four tips on how to run your business so it doesn’t happen to you.

What is Piercing The Corporate Veil?

The term piercing the corporate veil refers to a situation when a court chooses to set aside a business owners' limited liability protection. In essence, the protection that LLCs and corporations offer their owners is removed. Veil piercing – sometimes called lifting the veil – occurs most often in closely held corporations or in smaller operations.

In general, courts must have a strong reason to remove the limited liability protection of a business owner – reasons we’ll discuss in a moment. Courts normally do not pierce the veil unless some egregious act of misconduct occurs.

To fully understand this, it’s critical to have a firm grasp of limited liability. Limited liability means that the personal liability of a business owner for business debts is limited. In other words, limited liability shields the business owners' personal property and assets should the business find itself in trouble.

When you form a corporation or LLC, you form a separate entity in the eyes of the law. Should your small business succumb to debt that cannot be repaid, your personal assets are not in jeopardy – only the business assets are.

What are the Effects of Piercing the Corporate Veil?

If a court decides to remove your liability protection by piercing the veil, it could be devastating for you as a business owner – depending on the situation. It means that you as the business owner, and any other owning member or shareholder, are personally liable for the business debt.

This means that creditors can legally go after your house, car, boat, bank accounts, investments, and any other personal assets you own until the business debt is settled. If you are the only owner and your business is liable for a large sum of debt, it could be financially devastating.

When Will Courts Pierce The Corporate Veil?

As mentioned, courts need to find a serious act of misconduct before they pierce the veil. Here are common factors that courts consider when determining whether to pierce the veil or not.

• You and your company are not acting as separate entities. One of the biggest determining agents a court considers is if you fail to maintain legal separation between you and your business. If you do not have separate bank accounts for business and personal finances, frequently run personal expenses through the business account, or do not abide by corporate formalities, a court could consider your business to be your alter ego – instead of a distinct entity – and pierce the veil.
• The company’s actions were illegal or reckless. If you take on a large amount of debt knowing that you will not be able to pay the debt off and then use the money recklessly or dishonestly, a court could lift the veil on your business. Likewise, engaging in illegal activity can result in the veil being pierced as well as criminal charges.
• The company’s actions cause a financial loss to others. If you conduct business with another company and never pay your bill, and the other factors are present, a court could pierce the veil to settle the bill.
• Failure to capitalize the company. Courts will not punish a business for not making enough of a profit and will not pierce the veil for this reason alone. That being said, if you intentionally keep your business underfunded – by immediately transferring all profits into personal accounts – or do not have business assets adequate enough to cover business operations, a court could find that you are under-capitalizing your business.

What are Examples of Piercing the Corporate Veil?

Here are a couple of piercing the corporate veil examples to make this concept more tangible.

• In the court case Ocala Breeders’ Sales Co. v. Hialeah, Inc., the court pierced the veil and pursued liability of the corporate officers because they were using a subsidiary improperly. The court found that the subsidiary was just an instrument of the parent corporation (for many reasons) and since the subsidiary was not properly capitalized, it was unable to fulfill its contractual agreements.
• In the court case Broward Marine, Inc. v. S/V Zeus, a yacht company’s veil was pierced. In short, the company foreclosed on a yacht and the dominant shareholder transferred all company assets to another business account, of another company owned by that shareholder – to avoid paying anything. The court pierced the veil and held the dominant shareholder and the shareholder’s other company liable for the debt.

How Can You Avoid Piercing The Veil?

LLCs, corporations, and limited partnerships offer personal liability protection for the business owner(s). A sole proprietorship and general partnerships do not because they are not separate entities in the eyes of the law. In order to keep these liability protections, follow the steps here.

• Follow all necessary formalities. Corporations have the most formalities to follow, such as holding annual meetings, undertaking annual filings, and others. LLCs and LLPs also have formalities, such as creating operating agreements, recording meeting minutes for big decisions, and others. Following these formalities is important.
• Keep all business documents for 7 years. Whether it be meeting minutes or signed formal contracts, hold onto all business documentation for at least seven years so you can show a clear history of proper business conduct.
• Keep business and personal assets separate. Open a business bank account, business credit cards, and other business accounts. Keep all business financials separate from your personal financials.
• Properly capitalize your business. Make sure that your business has the capital, assets, and equipment it needs to operate at all times. You won’t be punished for not making money, but you could if you purposely underfund your business.
• Use your business name for all official documents. Put your business name on signage, business cards, advertisements, and other materials, and always use your business name when entering into contracts with other companies.

Need Help With Business Funding?

Do you need help getting funding for your business? We can help with EIDL, SBA loans, grants, or other business financing options. Get ongoing personalized help from our team. Join Skip Premium today and get 1-1 support for your business.

How Else Can Skip Help? Whether you need help navigating small business funding–like SBA loans, grants, or other financing options–or help with other government-related services–like TSA PreCheck or DMV appointments — skip the red tape.