Limited Liability has its Limits – Piercing the Corporate Veil

On June 28, 2007 by

Limited Liability has its Limits – Piercing the Corporate Veil
Why your LLC or Inc. isn’t as bulletproof as you may think.

Introduction
When starting a new business, it’s common for the business owner(s) to establish some sort of business entity in an effort to protect their personal assets against the debts or obligations incurred by the business. Two common types of business entities include the Limited Liability Company (LLC) and Corporation (Inc.).

The legal protections offered by these entities are plenty, with the law considering the entity as a separate and distinct “juridical person.” Just like one person isn’t typically liable for the debts of another person, the individual equity owners of a LLC or Inc. aren’t typically liable for the debts and obligations of their business.

However, while “limited liability” is one of the principal characteristics of business entities, the limited liability is not necessarily absolute.

When Limited Liability is Limited – Piercing the Corporate Veil
The doctrine of “veil piercing,” permits courts under certain circumstances to disregard an entity’s form and the protections from personal liability otherwise accorded to the members, shareholders or other equity holders. The doctrine most often arises in connection with a person’s attempt to hold corporate shareholders or LLC members liable for the debts of the organization.

Louisiana courts will pierce the corporate veil and hold its equity owners personally liable for a debt or obligation when the business organization is found to be simply the “alter ego” of the shareholder or when shareholders disregard the requisite corporate formalities to the extent that the corporation ceases to be distinguishable from its shareholders.

In the landmark 1991 case, Riggins v. Dixie Shoring Company, Inc., the Louisiana Supreme Court noted that in determining whether to pierce the corporate veil, the following factors are among those to be considered:

  1. Whether there is commingling of funds between the company and the equity owners (Members, Shareholders, etc.);
  2. Whether the organization follows statutory formalities for incorporating and transacting corporate affairs;
  3. Whether the organization is under-capitalized (did your company have enough start-up capitol? is your company properly capitalized?);
  4. Whether the company provides separate bank accounts and bookkeeping records for the organization;
  5. Whether the company holds regular shareholder and director meetings.

590 So.2d 1164.

The consideration of these factors, and others, will guide the court in determining whether your organization is truly a separate legal entity or simply the “alter ego” of your personal business affairs and transactions, thus holding you (i.e. Members/Shareholders) directly liable for the business’ debts and obligations.

On the positive note, in general, Louisiana courts are reluctant to pierce the corporate veil. The court stated in Riggins that “limited liability….should be disregarded only in exceptional circumstances.” Id. Further, when considering the above factors, whether the legal entity has failed in respect to any one factor is not always determinative. Instead the courts will consider the “totality of the circumstances” to make a decision.

Nevertheless, it is extremely important for business-persons operating their businesses through a Corporation, Limited Liability Company, or other business organization to rather intimately understand the veil piercing doctrine, and to run their businesses in conformity with it.

Protecting oneself from personal liability in the ordinary course of business is quite possible, but it oftentimes involves more than simply filing Articles with the Louisiana Secretary of State.

Big Business v. Small Business
Tips to Avoid the Doctrine of Veil Piercing

Let’s be honest – it’s a lot less likely for a court to pierce the corporate veil of a large and established business than to pierce the veil of a small or mid-size operation. Large companies will likely follow more formalities than small organizations (holding meetings, etc.), they will likely have lawyers on staff, and they will also likely have more than one, two, three or twenty shareholders and directors.

As a small business owner – or as a one-man operation – is there anything you can do to avoid being considered by law as simply the “alter ego” to your organization? After all, if it’s just you, how can the business not be your alter ego?

If a company only has one or a very few shareholder(s) or member(s), that factor will likely be considered by the Court in determining whether to pierce the veil of your organization. However, the law is fairly clear that this fact alone – that one individual owns all or a majority of the organization – does not support the drastic veil piercing event.

Therefore, here are some tips to help avoid the doctrine of veil piercing:

  1. Have a separate bank account for your business organization in that organization’s name. No exceptions.
  2. Do not “commingle” – or freely transfer – funds between your organization’s account and your personal account, or between different organizations. Talk to a lawyer or CPA about making proper distributions to Members, or perhaps loans from a Member to the organization.
  3. If you are a small operation and you have an Inc. or Corporation, consider changing to a Limited Liability Company. Inc.’s require that you hold mandatory meetings, have shareholders, directors and officers, and other tedious formalities. An LLC offers most of the liability protection of an Inc. and significantly less formalities.
  4. Make certain that you sign contracts and other legal documents as an agent for your organization, and do not simply sign your name without reference to your organization.
  5. Properly capitalize your organization.

Consult with an Attorney
There are slight and important differences between how the doctrine of “veil piercing” is applied to Corporations versus Limited Liability Companies in Louisiana. For the purposes of this short article, however, general principals of “veil piercing” were identified and explored. You should consult an attorney to learn more about these differences, the doctrine of veil piercing, and whether your organization is at-risk.

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