After years and years of careful planning and hard work, you created and are operating a successful business. Just as you begin to reap the benefits of your labor, boom – a judgment is entered against your business. Unable to pay the judgment from the business account, creditors seek to seize your personal assets – and win. The next thing you know, you are financially destitute alongside your once thriving business. You falsely thought your personal resources were protected by setting up your business. How could this have happened?
Corporations and limited liability companies (“LLCs”) are often used by business owners because they believe that their personal assets are protected from business liabilities if they do so. The protection of personal assets is referred to by lawyers as the “corporate veil.” While that belief is generally true, courts can order that the “corporate veil” be pierced for several reasons, jeopardizing the personal assets and finances of business owners, whether shareholders or members, of a company. Here are five mistakes to avoid in order to help ensure the protection of the corporate veil and protection from creditors:
Maintain the separate identities of the company or companies: Having several related affiliates or multiple companies acting under the umbrella of one company can blur the lines in maintaining separate identities of the companies. The corporate veil may be pierced if, for example, a parent company operates and controls a subsidiary company by providing all of the financing, reports having the same officers, business address and corporate information, or files consolidated taxes. The parent company cannot operate and control the subsidiary.
Maintain separate identities of the company and its owners: The corporation or LLC must be treated as a separate business, not an extension of the owners. Owners, whether shareholders or members, and the officers and managers, should avoid commingling funds and must treat assets of the business separate from personal assets.
Adequately capitalize the company: The corporation must maintain a level of assets that would be fair to creditors, which depends upon the purpose of the business. When the company is opened, it should have its own bank account with adequate funds to account for business operations.
Follow corporate formalities: Filing corporate tax returns, signing all contracts as the business or as officers of the organization, updating by-laws, maintaining stock or membership ledgers, holding initial and annual meetings of directors/managers and officers and maintaining status with the Arizona Corporation Commission by filing an Annual Report are a few formalities that should be adhered to in order to prevent piercing the corporate veil. Business activities should be documented, records should be adequately kept and stored and parties with whom business is conducted should be aware of the corporate or LLC status of the company.
Avoid committing fraud, wrongdoing or injustice to third parties: Let’s say, for example, that a company has a judgment entered against it. In order to avoid paying the judgment, the company closes down and transfers all of its assets to a new company operating a similar business – with the same assets and same employees. In this situation, the Court may easily find cause to order that the corporate veil be pierced. Consider an outsider’s perspective; if you think something could raise questions, consult legal counsel who can help guide you through a legal way to accomplish your goals.
In conclusion, business owners may help protect their personal assets by maintaining a fair level of assets and a clear distinction in handling the accounts for their corporation and personal affairs, while adhering to corporate formalities and avoiding wrongdoing. Creating and maintaining proper business practices to protect yourself can be perplexing; having a good attorney to advise you can be of tremendous value in preserving both your personal assets and your peace of mind.
Article Written By: Jill-Ann Weickhardt
Business & Commercial / Real Estate