Piercing the Corporate Veil — Why Corporate Formalities Are Important For Businesses

One of the advantages of incorporating a business is that incorporation can protect owners from being directly and personally responsible for the business’s debts and liabilities. Corporations are typically treated as legal entities separate from their owners. Therefore, if a business is sued, the owner is not typically responsible for the claims. Shareholders generally only invest their money into the corporation and are also not responsible for the company’s debts or for legal judgments against it. However, in some situations, piercing the corporate veil can allow plaintiffs to hold corporate shareholders personally liable for the corporation’s debts. If you are concerned about your corporation, consider contacting an experienced business lawyer at Von Rock Law by calling (866) 720-0195.

What Is Piercing the Corporate Veil?

The corporate veil is the protection of individuals who have formed the business. Piercing the corporate veil means that the court sets aside limited liability and holds the shareholders of a corporation personally liable for the business’s debts or actions. Piercing the corporate veil is also known as “alter ego liability” because the liability passes to the shareholder who is operating the business as a corporate alter ego.

Courts understand the importance of business protections and limited liability. Therefore, they are reluctant to pierce the corporate veil. This remedy may, however, be available in some cases, such as those involving particularly egregious behavior by corporate shareholders.

What Are Corporate Formalities?

There are certain formalities that corporations must follow in order to maintain a separate business identity. The State of California specifies the requirements for registering and maintaining a corporation as a separate legal entity for the purposes of conducting business. In addition to filing its initial registration with the state, the corporation must:

  • Create bylaws that discuss stockholder and director meetings, the number of officers, officer responsibilities, and other details about business operations
  • File articles of incorporation
  • Hold annual meetings
  • Keep written minutes
  • File an annual statement with the Secretary of State
  • Maintain a separate bank account and separate financial records
  • Pay minimum tax

How The Corporate Veil Can Be Pierced

California case law has developed a two-prong test to determine when the corporate veil can be pierced. Both of the following conditions must be met:

  • There must be a unity of interest, and
  • An inequitable result will arise if the corporate veil is not pierced.

There Must Be a Unity of Interest

The plaintiff must show that there is a unity of interest and ownership between the corporation and its owners so that there are no distinguishable identities between the two. Courts can consider many factors when determining whether there is a unity of interest. A unity of interest may be found when there are factors like:

  • Comingling of assets
  • Failing to keep separate business accounts
  • Diverting funds or assets
  • Absence of corporate assets
  • Under-capitalization
  • Failing to maintain meeting minutes
  • Concealing or misrepresenting ownership of the business
  • Failing to follow legal formalities
  • Failing to distinguish between different corporations
  • Concealing or misrepresenting personal business activities
  • Creating a corporate identity as a coverup for illegal transactions

A court will determine which factors are most relevant. No specific factor is conclusive, so the court must decide the matter based on the circumstances.

An Inequitable Result Will Arise if the Corporate Veil Is Not Pierced

The plaintiff must show that an inequitable result would occur if the actions related to the business are not passed on to the business owner. The intent of allowing the piercing of the corporate veil is to prevent fraud or injustice. Piercing the corporate veil does not occur outside litigation. The court must decide whether to pierce the corporate veil based on the individual circumstances.

How To Avoid Piercing the Corporate Veil

Fortunately, there are steps that your business may be able to take to avoid a court decision to pierce the corporate veil. A business lawyer from Von Rock Law may recommend taking these steps to maintain a separate business entity to minimize the risk of piercing the corporate veil.

Follow Corporate Formalities

Corporations must follow certain formalities to keep their legal status. They can maintain such formalities by:

  • Creating bylaws
  • Updating bylaws
  • Issuing shares of stock
  • Maintaining a stock transfer ledger
  • Holding annual director meetings
  • Holding annual shareholder meetings
  • Completing annual filings
  • Paying annual fees and corporate taxes

Properly Capitalize the Business

One of the most important actions business owners can take to protect the business is to properly capitalize the business at the outset and then as necessary. The funds should clearly be designated for the business and not to the individual business owner.

Document Business Decisions and Transactions

Business decisions should be clearly documented, and the information should be stored safely. Such documentation can be maintained via notes about:

  • Which major decisions had to be made
  • How meetings occurred
  • Who helped make decisions
  • Where meetings were held
  • Who kept minutes

Maintain Separate Business and Personal Finances

Another important way to distinguish the business from the individual owner(s) is to maintain separate accounts and finances for each. Business owners should not pay personal bills from corporate accounts. Personal and business funds should not be commingled. Instead, the business should have its own checking account, credit card, and other finances. Business owners should keep detailed records of the business’s finances. Business property should also be maintained separately from personal assets.

Use Your Corporate Name

The California Secretary of State describes a number of rules and formalities that must be followed by corporations and other business entities. Using a corporation’s legal business name where appropriate to differentiate businesses from individuals and from other business entities can help to decrease the likelihood of piercing the corporate veil for your business. You can include your formal business name on:

  • Business checking accounts and credit cards
  • Invoices sent to contractors and vendors
  • Employee paychecks
  • Business cards
  • Business contracts
  • Letterhead
  • Emails and other correspondence
  • Marketing materials
  • Business website

Contact an Experienced Business Lawyer for Assistance Today

A business lawyer may be able to review your company’s situation, help you establish a separate legal entity, develop documents that clearly define rules, and advise you of your legal options if you are facing litigation. If you are concerned about how piercing the corporate veil may impact your individual rights and responsibilities, consider reaching out to a knowledgeable business lawyer from Von Rock Law by calling (866) 720-0195 to schedule a confidential consultation today.

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