What You Need to Know
If you’re an owner or member of a limited liability company (LLC), it’s likely that one of the main reasons you chose this business structure is the personal asset protection it provides. However, the ability of an LLC to protect your assets is limited to your ability to maintain what’s known as “the corporate veil.”
The corporate veil is another term for your company’s limited liability status, and if it isn’t maintained correctly, it can be “pierced” — leaving your personal assets exposed to creditors in potential lawsuits. This is a thoroughly undesirable situation for any LLC to be in, so it is vital to know how you can avoid your corporate veil being pierced.
The most common reason to start a limited liability company is the protection afforded by a properly maintained corporate veil. This means that if your business is sued, your personal liability is limited to the amount of investment you’ve made in the company. Other than that, creditors are not able to pursue your home, your car, your belongings, or your personal money.
When your LLC’s corporate veil is pierced, you lose your limited liability status. At this point, your personal assets are fair game for creditors, which is a worst-case scenario for any entrepreneur. As such, it’s important that you do everything you can to keep your corporate veil intact at all times.
A court may choose to pierce your corporate veil if your LLC breaks three specific rules. Keep in mind that your company must violate all three of these guidelines in order to have your personal asset protection revoked.
First, the court needs to determine that your LLC is not a separate entity from you or, if you have multiple owners, from any of your other owners. If a court decides that the company is nothing more than an extension of its owner as an individual, then that company may be on its way to having its corporate veil pierced.
The most common way LLCs get into this type of trouble is by using company accounts to cover personal expenses. For example, using your company credit card at the grocery store to buy food for yourself or writing a check from your business bank account to make a mortgage payment on your home. These actions imply that the company is not truly a separate entity from its owner(s).
Secondly, the court must find that your LLC was used to commit fraudulent activities. Without solid proof of wrongdoing and intent, this can be difficult to prove in court. Some examples of fraudulent activities include borrowing money that the LLC cannot feasibly repay or making deals the company can’t keep. These and similar actions imply that the LLC’s ownership is not taking sufficient action to cover its debts.
Finally, your LLC’s corporate veil may be pierced if anyone the company does business with is left with unpaid bills due to your company’s insolvency. This may be in the form of debts your company never repaid or court settlements that are at least partially the fault of your LLC’s misconduct.
Thankfully, you can do quite a bit to maintain the effectiveness of your limited liability company’s corporate veil. If you stay focused on maintaining your LLC’s personal asset protection, you should be able to do so by following a few simple steps.
The first and most important step is to make sure your LLC is properly formed from the start. You’ll need to correctly prepare and file your articles of organization, name an eligible registered agent, and file an initial report (if necessary). By following your state’s guidelines properly, you can ensure your company’s corporate veil is intact from day one.
Next, you’ll need to ensure appropriate maintenance of your LLC once it’s formed. What this means is that you should make certain to always file your annual reports in a timely fashion, and stay on top of any other maintenance requirements set forth by your state of formation.
Another important step is investing enough money into your LLC. If you don’t have enough capital for your business to operate effectively, it can be a big problem for your corporate veil status. An LLC that is adequately capitalized can make a much stronger case for itself when it comes to accusations that may strip it of its corporate veil.
Next, you must ensure that you never commingle your business assets with your own personal assets. If you fail to do so, you will make your company vulnerable to legal action. While this can be more difficult for single-member LLCs, a few simple actions like setting up a separate business bank account and never using your LLC credit card for personal purchases can keep you protected.
Remember, you can transfer funds between your own accounts and those of your business, but if you do, you’ll need to properly document these transactions as a loan from one entity to the other.
One of the best and easiest ways to keep your LLC assets separate from your own personal possessions is to record all of your business endeavors with accounting software. Not only is this a good way to prove that you’re treating your LLC as a separate entity, but it’s also a smart bookkeeping practice. Keeping records of all business transactions is a good idea for every business, both for internal organization and protection in case of an unexpected lawsuit.
Finally, you should always sign documents as a representative of your company, not merely as yourself. If you only sign your own personal name, it’s harder to prove that you and the LLC are separate entities. When signing documents for your business, make sure to sign your own name along with the company name. This will prevent any confusion.
The corporate veil only provides personal asset protection in certain ways. It’s possible for creditors to pursue your personal assets through a few different methods even if they can’t pierce your corporate veil.
Maintaining corporate veil protection as a single-member LLC can be more difficult for a few reasons. To start, the process for piercing the corporate veil of a single-member LLC only requires that two conditions be met, rather than three. They are:
By nature, it is more difficult for the owner of a single-member LLC to keep their business assets separate from their personal assets. It is also more common for a single-member LLC to keep poorly detailed business records, since they are the only person involved in the business. Under these conditions, it can be exceedingly difficult to prove yourself innocent of either charge required to pierce your corporate veil.
For these reasons, it’s critical that you treat your single-member LLC the way you would one with multiple members. Maintain separate business assets, materials, and equipment at all times, and maintain impeccable records to prove that your LLC is operating within state regulations should legal action ever be brought against you.
There’s quite a bit to keep in mind when it comes to maintaining your limited liability company’s corporate veil, whether your LLC is single-member or multi-member. In general, you should make sure to never commingle assets, and to keep detailed records of all your business activities.
If you do a good job managing these items, the rest of the advice provided above should fall into place. Maintaining your corporate veil is critically important to protecting yourself, your fellow LLC members, and your business from legal action.