What Is the Corporate Veil and Why Is It Important to Small Business Owners?

What Is the Corporate Veil and Why Is It Important to Small Business Owners?

What Is the Corporate Veil and Why Is It Important to Small Business Owners?

  • The corporate veil is a term that refers to the legal separation of a limited liability company (LLC) or other corporation from its owners or shareholders.
  • LLCs enjoy more asset protection for a company’s debts or legal troubles than sole proprietorships, but if owners or partners are careless, the corporate owners can lose their liability protection.
  • When a company’s owners, members, or shareholders fail to uphold the legal separation of the business from their personal situations, a court may determine they are personally responsible for its business liabilities, which is known as piercing the corporate veil.
  • Find out more about the corporate veil and what piercing it can mean for a small business owner or entrepreneur in this article from Nav’s experts. 

What Is the Meaning of the Corporate Veil? 

The term “corporate veil” refers to the protection that a limited liability company (LLC) or other corporation provides to the individuals who own or manage the business when the LLC is upheld as a separate legal entity. When an entrepreneur or group forms an LLC, they’re generally shielded from personal liability for the business entity’s debts or legal issues. This means that their personal assets — like their homes or other real estate, vehicles, retirement funds, or personal bank accounts — can’t be seized to pay off the business debts if the business defaults on a loan, gets sued, becomes insolvent, or declares bankruptcy. 

Why Is a Corporate Veil Important?

The corporate veil is important because it protects business owners, shareholders, and partners from having to pay for corporate debts, liabilities, or lawsuits with their own money or assets. But the corporate veil has to be actively kept intact through action (or inaction) on the part of the owner or owners of the LLC. If the managers, members, owners, or shareholders of an LLC fail to uphold or maintain the corporate veil, they may have to pay for the business’s troubles with their own money or assets. 

How Do I Create a Corporate Veil?

To create and maintain a corporate veil, you have to deal with a few corporate formalities to make sure that your business is a separate entity from your person, or persons in the case of a general partnership or limited partnership. 

First, make sure that you follow all the rules and regulations in your state and local jurisdiction in terms of establishing the LLC. Next, you’ll need to adequately separate the business’s dealings from your personal life, especially when it comes to financing. The best ways to do this are to make sure you have a separate business bank account and separate business credit cards from your personal accounts, and that you never use the business account for personal matters (or vice versa). 

Finally, make sure that you and any partners maintain the corporate entity. You’ll need to keep up with incorporation requirements — like filing annual reports, keeping meeting minutes for shareholder meetings or board of director meetings, and following refiling requirements. Also, make sure you follow corporate law, like ensuring that your business isn’t putting profit above the general good of society. 

How Hard Is It to Pierce the Corporate Veil?

In order for a corporate veil piercing to occur, a court has to find that the owners, shareholders, or members of an LLC failed to maintain the separation between the business entity and their personal lives. This can happen if a business goes through insolvency and is unable to pay its creditors with its corporate assets. The creditors or lenders may sue the corporate shareholders to settle the company’s debts and go after the personal assets of members if the business assets won’t cover the debts. If the owners of the LLC haven’t been careful in maintaining the legal entity as a separate business structure from their personal lives or have engaged in shady business activities, a court could find them personally liable. 

Piercing of the corporate veil is a long, expensive court process, but small businesses are particularly vulnerable to being found at fault. Big companies acting as parent companies to underfunded subsidiaries can also have their corporate veils pierced, especially if their creditors suffered very serious economic losses. 

How Do You Avoid Piercing the Corporate Veil in an LLC?

There are several ways that you can avoid piercing the corporate veil for your small business, for instance by:

  • Properly forming the business entity — you must form your LLC in line with state law and by following the rules to form it, such as registering or filing it with the state, appointing a registered agent, etc.
  • Maintaining the LLC — you can maintain the business entity by keeping good corporate records, refiling annually as required, keeping up with annual reports, your operating agreement, and notes on any shareholder meetings or annual meetings with your board of directors as required. 
  • Avoiding commingling assets — keep separate bank accounts between your personal and business finances and avoid intermingling them; also, don’t use business credit cards to pay for personal purchases, or vice versa.
  • Separate collateral and personal guarantees — when you’re applying for small business loans or other financing, ensure that you’re not using personal assets as collateral
  • Maintain compliance — make sure that your business is keeping up with any licenses or permits or any other compliance requirements. 
  • Keep everything legal and above board — make sure that your company is following laws and regulations, and that you’re never doing anything that could put other people at risk or danger.

Keeping your LLC intact and protecting yourself from liability by maintaining the corporate veil can help you avoid bad legal situations and financial difficulties.

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