Guide to the Corporate Veil
What Is the Corporate Veil?
The corporate veil is the legal concept that the corporation is a legal entity separate from its owners (members or shareholders). This is the aspect of a corporation that provides personal liability protection for the owners of the corporation.
Importantly, establishing a corporate veil begins with adequately capitalizing the company and maintaining separate business and personal assets. When your personal and business accounts are mixed, your personal assets (including your home, your car, and other valuables) could be at risk in the event someone sues your business. In business law, this is referred to as piercing the corporate veil.
What Does It Mean to Pierce the Corporate Veil?
So what is piercing the corporate veil? Piercing the corporate veil is the legal notion of considering the actions and liabilities of the corporation as the personal liability of the directors or shareholders of the company. If the corporate veil is pierced, there is no more liability protection.
While an LLC or corporation generally provides personal liability protection to its owners, in certain situations, the court can rule that the corporate veil was broken and hold the owners of the LLC or corporation personally liable.
Although the regulations and laws concerning maintaining the corporate veil vary by state, there are a number of situations that raise red flags and may lead the courts to find that the corporate veil has been pierced. These include:
- Fraud or wrongdoing
- Insufficient startup capital
- Failing to maintain separation between the company and its owners
- Failing to follow corporate formalities
How to Maintain Your Corporate Veil
In order to establish and retain liability protection, the business and its owners must maintain a corporate veil. This means operating the corporation as a separate legal entity. This includes having sufficient startup capital, maintaining separation between the corporation and its owners, registering your business correctly and filing the right documents, keeping your corporate records updated, and filing required documents and quarterly, biennial, and annual reports on time.
The most common reason that the courts find to pierce the corporate veil is fraud and wrongdoing. To maintain your corporate veil, you must act in an honest and truthful manner and follow all rules, regulations, and laws that apply to your company and its operations.
You break the corporate veil if you use an LLC or corporation to engage in negligent, fraudulent, or unlawful acts. For instance, if the owners of an LLC or corporation recklessly borrowed money, entered into contracts that they knew the corporation could not pay, or ignored rules and regulations in a negligent manner, then the court may find that the owners pierced the corporate veil.
While the courts are unlikely to punish innocent parties, individuals who are found responsible will lose their personal liability protection, and the corporation itself could be punished as well. This means that litigants and creditors will go after the personal bank accounts, homes, and assets of any responsible individuals.
One way to prevent fraud and wrongdoing is to find a startup lawyer and consult with your legal counsel if the legality of anything is even questionable.
The first step in establishing and maintaining a corporate veil is having sufficient startup capital. In order to establish and maintain your corporate veil, you need to make a reasonable initial investment into your startup.
If the business did not have adequate startup funds or funds to operate, it was never really a separate entity apart from its members or shareholders. It could never have stood on its own. Therefore, the business should have its own bank account and an adequate amount of startup capital or a plan to raise adequate startup capital.
If the business was undercapitalized and incurs excessive debt, the courts may find that the amount of assets available to the corporation’s creditors is inequitable and hold the owners or shareholders personally liable for the corporation's debts.
Another important step to establishing and maintaining a corporate veil is to maintain a separation between the company and its owners. This includes separating personal and business assets by opening separate business bank accounts, owning business credit cards, setting up accounting, and building business credit.
Open a Business Bank Account
A business bank account helps you separate your business and personal finances, adds professionalism and legitimacy to your new venture and helps prevent piercing the corporate veil.
Business bank accounts also help keep your corporate records organized, another important step in maintaining your corporate veil.
The first accounts you will need to open are business checking accounts and business savings accounts. This is the first step in separating your business and personal finances.
We highly recommend reading our review of the best bank accounts for startups and entrepreneurs to help you choose the right bank account for your business.
Get a Business Credit Card
Credit cards are an important source of funding for startups and small businesses, and they can provide some financial flexibility in between funding cycles, during slow periods, or for unexpected expenses.
However, if you find yourself relying on credit cards as a source of funding or in order to provide that extra financial flexibility, you will need to open a business credit card rather than relying on your personal cards in order to keep your business and personal accounts separated.
There are many different types of small business credit cards, each with its own mix of interest rates, fees, benefits, and rewards.
Read our guide on the best business credit cards to find the right business credit card for your business.
Set Up Accounting
Business accounting is an important (and required) aspect of operating a startup for both legal and tax purposes and is another necessary aspect of maintaining your corporate veil.
There are a number of options for handling your business accounting, including hiring an in-house accountant, hiring a bookkeeper, using a payroll service, or using small business accounting software. However, no matter how you handle your startup’s accounting, you will need to have an accounting system in place to maintain separation between the corporation and its owners.
Recommended: Schedule a consultation with a business accountant today to find out how much time and money your business could save on tax, payroll, and bookkeeping services.
Building Business Credit
Another way to separate personal and business assets is to begin building business credit. Building business credit involves establishing your business’s fundability, getting listed with business credit bureaus like Dun & Bradstreet, and establishing credit lines while keeping them in good standing.
Read our guide on how to set up business credit for the first time to learn more about getting started with business credit, which mistakes to avoid, how to use net-30 vendors to build credit, and how to build business credit.
In order to establish and maintain your corporate veil, you will also need to follow corporate formalities — the rules for establishing and maintaining an LLC or corporation in your state. These include filing the right documents, signing documents correctly, keeping updated corporate records, and filing required reports on time.
Follow Naming Rules
First, your business must be named appropriately. LLCs and corporations need to follow specific naming rules to identify their business as an LLC or corporation, such as including the right words or acronyms such as “corporation,” “incorporated,” “inc.,” or “LLC” and use the proper name in all communications and messaging.
File the Right Documents
Your LLC or corporation needs to be registered in your state (or the state you choose) to be recognized as a separate legal entity. The formation documents for LLCs and corporations vary by state. You will likely need to file a number of filing documents as well as an annual report with your state.
To learn more about how to incorporate your startup and the formation documents you will need, read our guide on how to incorporate a startup, or for more detailed information for the requirements in your state, see our state-by-state guides on how to form an LLC or how to start a corporation.
Sign Documents Correctly
Anyone you do business with needs to know that they are doing business with a corporation and that you are only acting on its behalf. This includes not providing personal guarantees and signing documents correctly.
In order to keep your corporation and your personal affairs separated, you also can not offer to personally guarantee any debts or liabilities of your business. A personal guarantee commingles your affairs with those of the corporation and pierces the corporate veil.
Directors, officers, and the organization’s management must also clearly specifying their role in representing the organization (i.e., Mellisa Smith, CEO, ABC Industries) when acting on the organization’s behalf or signing any documents. Signing documents in your personal capacity vs. signing documents on behalf of the corporation may also fail to maintain and protect your corporate veil.
Keep Corporate Records Updated
Corporations are also required to hold annual meetings among their members, directors, and shareholders in order to keep detailed records of any important decisions made by their owners or directors. These records, called “minutes,” are often kept in a “minute book” to keep track of periodic director meetings and the annual meeting.
You must maintain accurate accounting and tax records. Minutes need to be maintained for all directors and shareholder meetings. You must also maintain stock and ownership records and keep them updated.
You will also need to keep your bylaws up to date. To amend a section or article of your corporation’s bylaws, you must call a special meeting with the board of directors, who must first vote on the proposed changes. Depending on your bylaw structure, either a majority vote or minimum vote will be required to pass the amendment.
After the first meeting, notices must be sent to the corporation’s shareholders, and a second meeting must be held for all shareholders to either approve or disapprove your proposed amendments.
File Annual or Biennial Reports on Time
Your LLC or corporation may also be required to file quarterly, biennial, and annual reports. Most states require both LLCs and corporations to file an annual report in order to remain in compliance with their rules and regulations.
Corporations are also required to file reports with their shareholders. Although the rules for privately held corporations vary by state, public companies are required to provide periodic and annual reports and certified financial information to their stockholders, including audited balance sheets and profit and loss statements.
Again, requirements and due dates for reporting requirements vary by state, but it is your responsibility to follow your state’s rules and requirements. Failure to file or failure to file on time may subject your corporation to penalties and fines and may put your corporate veil at risk.
For help preparing and filing annual reports, consider using an annual report filing service. See our guide on the best annual report filing services for help finding the right report filing service for you and your business.
If you have any questions on maintaining a corporate veil, we recommend consulting with a startup lawyer to understand the rules and regulations regarding maintaining the corporate veil in your state.