Many people form a corporation or an LLC to provide personal liability protection. This desired protection is typically financial in nature, and can include desired protection from liability for company taxes, liability for company indebtedness, and especially liability for lawsuits against the company. While most people don’t want their company to be sued and suffer loss, most people more importantly do not want to suffer loss of personal finances and assets.
A corporate veil is not a physical object, but rather is a legal term that represents a barrier making owners not be liable for corporate actions. The term corporate veil can apply to shareholder owners of a corporation, and member owners of an LLC. Piercing of the corporate veil is terminology indicative of the corporate veil not providing separation and liability protection for owners. It is important to maintain a good corporate veil to prevent piercing of the corporate veil.
For corporations, one of the things that should be done to maintain the corporate veil is maintenance of the corporate book and corporate records. This can include but may not be limited to a corporate book with bylaws, minutes of an organization meeting, stock certificates, a stock transfer ledger, meeting minutes, and initial corporate tax status filings and identifiers including a federal Employer Identification Number (EIN). In Pennsylvania, articles of incorporation and the docketing statement should also be kept in the corporate book. Meeting minutes of the required annual meeting of the shareholders should be kept in the corporate book, and should include important decisions, votes of the shareholders, meeting notices or waivers thereof, and records of shareholder voting for corporate officers. Financial records and tax records should also be kept as well as meeting minutes for meetings of the board of directors.
LLC’s offer somewhat more flexibility and less formality, but it is also important for LLC member owners to keep corporate records. These records include but are not limited to, an operating agreement, financial and tax records, membership and percentage of ownership records, and meeting minutes. Proper LLC records are important to demonstrate separation of the company and owners.
For both corporations and LLC’s, it is very important not to comingle funds. A separate company bank account should be maintained. Money owed to the company should be paid to the company and deposited in a company bank account. Money that the company owes should be paid from the company bank account. Transactions between owners of the company and the company should be documented. This includes but is not limited to loans to the company, distributions from the company, salaries, and capital investments by owners. Money owed to the company in the form of an account receivable (AR) should not go directly to an owner, but rather needs to go into the corporate account before being transferred to an owner. Likewise, money that a company owes in the form of an account payable (AP) should not go directly from the owner to a third party. If the company does not have funds to pay an invoice, an owner can document and loan money to the company. This loan should be deposited into the company bank account for the company to pay the invoice from the company bank account. Comingling of funds might very well be indicative that the company is not really operating as a separate entity from the owners, and thus allow for piercing of the corporate veil producing owner liability for corporate liabilities.
I have explained to clients in the past that an analogy in part may be to think of the company as a neighbor. If your neighbor is involved in an accident that you have nothing to do with, it is likely that you will not have any liability for your neighbor’s actions in the accident. Likewise, it is important to treat the company as a separate entity to not have liability for actions of the company. In another analogy, you might be inclined to loan money to your neighbor. If you did make a loan to your neighbor, it would be a good idea to make a written expression of the transaction and the neighbor’s obligation or duty to repay the money. Likewise, it is important to document all financial transactions between a company and its owners to demonstrate that the company is operating as a separate entity, separate and distinct from the owners.
It is worthy of mention that protection by the corporate veil has many limitations. In many instances, professionals may not be protected with respect to professional liability. Furthermore, the corporate veil will likely not provide liability protection for things such as fraud or illegal activity. Additionally, owners may be liable for company taxes in certain situations, including employment taxes and withholdings. However, there are many situations in which a properly maintained corporate veil can, and often does provide liability protection for owners. All things considered, it is recommended that liability insurance be maintained for companies, professionals, and business owners.
For more information on similar or other business issues, please visit www.MentchLaw.com or call today. If you are searching for a business lawyer near me or business attorney near me, it is hoped that you will consider working with Mentch Law.
Attorney Kirk E. Mentch, Esquire