One of the main reasons why many individuals choose to incorporate or to form an LLC is to limit their personal liability for business debts and obligations. However, there are cases in which a party may pursue an owner’s personal assets and income for company debt. A South Carolina corporate attorney can help ensure that a corporation is set up properly to reduce the personal liability of the owners.
What is Meant by Piercing the Corporate Veil?
An owner, member, or another party may voluntarily sign a personal guarantee to be responsible for a specific business debt. In this instance, the person agrees that if the company does not pay the debt, he or she will guarantee payment of the debt. The party owed the debt can take available legal action to collect the debt from anyone who signed a personal guarantee.
However, absent a personal guarantee, owners, shareholders, and members of an LLC or corporation are typically not liable for business debts or causes of action. A party who is owed a debt or has a cause of action against the company is limited in its pursuit of the debt to the company’s resources and property. The company’s “veil” is the legal separation between the owners and the company.
When a party is permitted to hold a corporation or LLC’s members, owners, or shareholders personally responsible for obligations or debts of the business, it is called “piercing the corporate veil.” The legal separation between the owners and the company is removed, allowing a party to pursue legal action against the owners for business debts and obligations.
Reasons Why the Corporate Veil May be Pierced
If a corporation or LLC is set up properly, it is difficult to pierce the corporate veil. Courts do not allow creditors and other parties to pierce the veil except under specific circumstances.
The three most common reasons for piercing the corporate veil are when the owners of the corporation or LLC do not maintain separation between company and personal assets or maintain the formalities required for an LLC or corporation; fraud, and undercapitalization.
Failing to Maintain Separation and Corporate Formalities
For instance, an owner may commingle income in a joint account instead of using separate accounts for business income and personal income. The owner may title business property in his or her personal name or vice versa. An owner may also neglect to file required state or federal annual reports, maintain corporate ledgers and books, hold annual meetings, or update bylaws as necessary.
Fraud and Wrongdoing
If the owners commit fraud, misuse company assets, or commit other wrongdoing that benefits the company over the public good, courts may allow parties to pierce the corporate veil. Fraud may include making misrepresentations to investors or creditors to obtain loans and capital. Wrongdoing may include acts that intentionally or willfully place parties at risk of harm or injury.
Undercapitalization occurs when owners purposefully fail to ensure that the company has sufficient capital to cover operating expenses. It could occur when shareholders or owners take larger distributions than they should, thereby placing the company at risk of not having funds to pay its debts. It could also include owners or shareholders intentionally reducing their initial investment, thereby placing a higher degree of risk on lenders if the company fails.
Contact a South Carolina Corporate Attorney for More Information
Losing the protection of the corporate veil can be costly for owners, members, and shareholders. Personal lawsuits can be costly to defend, even if you prevail. A South Carolina corporate attorney can provide guidance and legal counsel to help you avoid this situation and defend your company and yourself if a party file an action to pierce the corporate veil. Contact Willcox, Buyck & Williams, PA to learn more about protecting yourself from liability.