Piercing the Corporate Veil
As discussed at length on this website, one of the most useful aspects of forming a corporation, an LLC or an LLP is the protection of your personal assets. Generally, if the business you own is one of these entities, you are not personally liable for the debts and liabilities of the company.
There is an exception to this rule. All to frequently, this exception is ignored by new business owners, who, by the nature of being a new business is probably more likely to have the exception applied to them.
The exception is referred to as the piercing of the corporate veil or corporate shield. Essentially, if your company is really run for the personal benefit of its owners and the company is a "mere instrumentality" of the owners rendering it "unjust" to keep them separate.
There are actually 17 factors under California law that can lead to the piercing of the corporate shiled. The most important questions that a Court will ask are:
- Was the company and its owners acting as a single economic unit? Did they adequately capitlize the company (putting money into the company and keeping money in the company rather than taking it out for personal use)? Is the company solvent? Were corporate formalities observed? Did the owners/shareholders/members siphon company funds for their personal use?
- Did the company really act as a facade for the dominate owner/shareholder/member? Did he/she pay personal expenses out of business acounts or pay business expenses out of personal accounts?
- Would it be unjust or unfair to keep the corporate sheild intact?
Generally, the most important factor that comes up time and time again in caselaw is whether the company was adequately capitalized. If the owners/shareolders/members took the entirety of company money out of the acount each month or paid themselves a salary equal to the total profit of the company, the company won't be able to cover any liabilities that arise, in which case a court will likely pierce the corporate veil.
One key factor to note is that the observence of corporate formalities is an important factor. Thus, even though you aren't required to have an operating agreement in place if you're an LLC, having one in place greatly strengthens your corporate shield.
*This article is for informational purposes only. It is not guaranteed to be a complete or thorough analysis of the issues discussed herein. It in no way shall serve to create an attorney-client relationship. The reader is advised to check for changes to current law and to consult with a qualified attorney on any legal issue.
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