A significant benefit of forming an LLC or other business entity is the protection it provides business owners from liability. Generally, owners and members of LLC’s are not personally liable for the debts and actions of the LLC itself. However, merely filing the requisite documents with the Secretary of State will not automatically provide the protection afforded by an LLC. Rather, LLC owners and members must make continuous efforts to ensure the LLC is an entity that is separate and distinct from its owner.
“Piercing the corporate veil” is what courts call disregarding a business as an independent entity and holding the individual business owner liable for the actions and debts of the business. Courts are willing to pierce the corporate veil when it is in the best interest of justice or fairness to do so. Factors a court considers when deciding to disregard a business as a separate entity include (1) whether control over the business by its owner was so complete that the business had no separate mind, will, or existence of its own, (2) whether control over the business by its owner was exercised in such a manner as to commit fraud or an illegal act against the person seeking to pierce the corporate veil, and (3) whether injury or unjust loss resulted from such control and wrong.
In looking at the first factor, whether the business had a mind or will of its own, courts will look for a variety of supporting evidence. Such evidence includes, among other things, whether the business bank accounts carried a balance that was sufficient to maintain ongoing operations and pay creditors. Other evidence could include the failure to follow business formalities as required by statute or by the business’ bylaws or other operating agreement. Failure to maintain business records could also be relevant evidence. Finally, co-mingling business funds and assets with the owner’s personal funds and assets could be relevant in determining whether it is appropriate to hold a business owner personally liable by piercing the corporate veil.
The second factor regarding fraud or illegal conduct by no means requires criminal activity. Instead, it requires some unjust or inequitable conduct by the owner under the guise of his or her business. Such conduct could include, among other things, breach of contract or grossly negligent conduct.
Finally, the third factor requires that a plaintiff actually suffered an unjust loss as a result of the business owner’s conduct under the guise of his or her business. If a plaintiff did not suffer any unjust lost, then there is no reason to pierce the corporate veil.
Running a small business is no easy task. Managing day to day operations, hiring and managing employees, accounting, scheduling, and marketing takes a great deal of time and talent. Unfortunately, with limited time, business owners sometimes disregard the importance of establishing and following governing documents and strict business practices. However, failure to do so could have serious consequences. As such, small business owners should review their current practices with an eye toward strict compliance with best practices and their businesses governing documents.