Protecting the corporate veil

If you own a business, I’m sure you have heard about the value of incorporation. It is supposed to protect you, personally, from lawsuits . . . or, at least, from the potential effects of lawsuits.

As Allan Branch writes:

The Corporate Veil is the legal shield that protects an individual from being personally liable for the actions of his/her company. This only applies to owners, partners, board members, not employees or share holders. In this country a person, or a company may sue any other person or company for anything, at any time. But there is only one reason to sue, and that is to be awarded money. So if a person or company doesn’t have any money, then there isn’t really anything to sue for.

Unless of course, if there is no corporate veil, then they can come after you personally. This could leave you financially ruined for the rest of your life.

Now I read an article called Piercing the Corporate Veil: How limited is the liability of doing business as a corporation? by Joe M. Hawbaker, Attorney at Law.

Frankly, after reading Hawbaker’s article, I am astonished at how potentially lightweight the protection of a corporation may be.

Want to maintain privacy? Not under these circumstances:

In the family setting, in particular in divorces where child support obligations are at issue, the corporate shield offers little real protection. For example, in a divorce, the courts are charged to determine the total monthly income of the divorcing parties from all sources. In such circumstances, the court will ignore the corporate veil in order to determine the actual earning potential of a shareholder: How much are corporate benefits worth? Does the corporate salary reflect real income potential? Are corporate funds being used for other purposes which are less important than child support? As one court stated: “The support of one’s children is a fundamental obligation which takes precedence over almost everything else.”

The courts are also willing to pierce the corporate veil with little, if any, hesitation where the corporation has been used to defraud third parties. A person who lies, or misrepresents an important fact, to another person in order to get that person to do business with the corporation will be liable to that person. Where the corporation itself commits fraud, Nebraska courts will disregard the corporate fiction and hold those people in the corporation who are responsible for that fraud liable in their individual capacities. Responsibility for corporate fraud may be based not only on active personal involvement in the fraud, but on the actions of agents or on approval or ratification of the fraud.

Hawbaker notes that,

In trying to determine whether or not to pierce a corporate veil in order to prevent fraud or injustice, a court will look at the following factors, which are not acts of fraud in themselves but which may be seen as evidence of fraud:

Grossly Inadequate Capitalization: Were the assets put into the corporation very small in relation to the nature of the business of the corporation and the risks of that business. . . .

Insolvency: Was the corporation insolvent when a debt or contractual obligation was incurred? A corporation is insolvent if it is unable to pay debts as they come due in the ordinary course of business. It may also be insolvent if it has considerably more liabilities than assets.

Diversion of Funds: Have shareholders taken corporate funds and used them for personal purposes?

And, of course, the things about which every one of us who has newly incorporated are warned:

Disregard of Corporate Formalities: [A failure] . . . to conduct business as an officer of the corporation, to deal with third parties through the corporation, to hold annual meetings, to keep corporate records, etc. [Note, h]owever, failure to observe corporate formalities alone will not typically support an effort to pierce the corporate veil. It may be used as evidence, however, of a lack of difference between the owner and the corporation. (See the next point.)

Disregard of the Corporate Entity: The corporate veil may be pierced where the owner of a corporation and the corporation itself cannot be distinguished.

Just because a corporation is unable to pay its obligations does not mean its corporate veil will be pierced. But if one or more of the five factors listed above proves true, you may expect an assault upon the veil.

Obviously, if you want to avoid trouble, you want to avoid engaging in any practices that are less than honorable. Biblical principles like making sure your “yes” means “yes” and your “no,” “no,” (Matthew 5:37) or about keeping your word even when it hurts (Psalm 15:4) still hold.

To read Hawbaker’s full article, visit the University of Nebraska, Lincoln, Center for Rural Affairs website. The article is available there along with at least two others that should be useful for a general audience: one on Long-Term Care and another on Medicaid.

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