PIERCING THE VEIL
HOW TO PROTECT YOUR LIMITED LIABILITY STATUS

Though there may be many reasons for forming a business entity of one type or another, one of the most important reasons is the limited liability of individual owners for the debts and obligations of the company.  Unlimited personal liability for the debts and obligations of the business exists for general partners in a partnership and sole proprietors.  Owners of limited liability entities, such as corporations or limited liability companies, on the other hand have personal liability for the debts and obligations of the business only to the extent of their invested capital and to the extent that they may have assumed personal responsibility for the same.  This article will provide suggestions on how to protect the limited liability status of the entity you have formed.

The purpose behind limited liability protection is to promote investment and commerce by allowing owners to limit their risks.  While owners may from time to time choose to personally guarantee debts, on occasion the limited liability protection is unknowingly lost and owners, officers and/or directors subsequently find out too late from a judge that they have become personally liable for the debts and obligations of the company.  Courts impose this personal liability by  “piercing the corporate veil” pursuant to what is known as the “alter ego” theory.  In other words the Court determines that the company and its owner(s) are really one in the same.

While Courts in the State of Utah take a cautious approach and do not impose personal liability casually, under certain conditions Courts will absolutely pierce the corporate veil and impose liability on owners.   A two-part test has been developed by the Utah Supreme Court to assist in determining when to disregard the entity and impose personal liability.  “[I]n order to disregard the corporate entity, there must be a concurrence of two circumstances: (1) there must be such unity of interest and ownership that the separate personalities of the corporation and the individual no longer exist, viz., the corporation is, in fact, the alter ego of one or a few individuals; and (2) the observance of the corporate form would sanction a fraud, promote injustice, or an inequitable result would follow.”   Understand that it is not necessary that you intend to commit fraud, only that an injustice would result.  The question then becomes, what can owners, directors, and/or officers do to help ensure the Courts will treat the company as a separate entity and not as the alter ego of the owners.  While no guarantees can be made, what follows is a list of relatively easy steps that can be taken and if faithfully observed will go a long way in shielding owners from personal liability:

  1. Make sure your company has been properly formed –
    a. Have you ever been issued shares?
    b. Did you pay for those shares?
  2. Ensure that the business was initially capitalized and continues to maintain adequate capitalization;
  3. Create good corporate records – document with minutes all meeting and obtain signed consents where appropriate.
  4. Hold annual director and shareholder meetings.  It may seem silly in the setting of a single shareholder corporation, but it is still important.
  5. If you are in a corporation, pay dividends when appropriate and do not pay them when it is inappropriate.
  6. If you are in a corporation, set a salary for yourself and remember the more often you change your salary the more it begins to look like you are siphoning funds or treating corporate funds as personal.
  7. DO NOT PAY PERSONAL DEBTS WITH COMPANY FUNDS.
  8. Maintain a separate bank account for the corporation -- personal monies and company monies should not be co-mingled.
  9. Limit loans between the shareholders and the corporation. If loans are made, ensure that proper documentation exists and make payments in accordance with the terms of the loan.
  10. Do not co-mingle other personal and company property.
  11. Keep good financial records.
  12. Sign contracts in the name of the corporation and not in your personal name.
  13. Always use the correct company name, on letterhead, in your advertisements, and in your other business dealings – make sure customers, suppliers, etc. know who they are dealing with.
  14. Do not give verbal assurances that you will cover an obligation if the company cannot cover the same.

The smaller the company the more difficult some of these tasks become. However, in small single owner businesses or home-based businesses observing the above suggestions is even more important because of the greater likelihood of alter ego problems.             

Most of the discussion in this article has centered on corporations and not limited liability companies (LLCs).  Because LLCs are such new entities case law has not yet fully developed regarding the application of this doctrine.  Further, the Utah Revised Limited Liability Act provides: “The failure of a company to maintain records, to hold meetings, or to observe any formalities or requirements imposed by this chapter or by the articles of organization or the operating agreement is not a ground for imposing personal liability on any member, manager, or employee for any debt, obligation, or liability of the company.” U.C.A. §48-2c-605.  This statute appears capable of being construed to abrogate the “alter ego” doctrine as it may be applied to LLCs.  However, other jurisdictions have pierced the LLC veil.  Thus it would still be the prudent course and good business practice to maintain many of the formalities set forth above.  Especially important and hopefully obvious is to avoid using the entity to promote fraud or injustice.  You will receive no sympathy from the Court if this was your path. Finally, remember that if you treat the company like a separate entity the courts will be much more likely to do the same.  Running a business can be a complex matter.  If you have questions make sure you seek competent help in finding the answers.