Many small business owners inadvertently blur the line between their business accounts and their personal accounts. In many cases it may be a matter of practical need, but the long term consequences can be severe. What do you need to know about the protections of an LLC or corporate entity and how to prevent a creditor from piercing your corporate veil in California?
The entire reason to have a business entity for most is to separate personal liability from business liability. The LLC, S-Corporation or C-Corporation becomes its own legal entity including the right to own property, enter into debt and transact goods and services. When the company enters into debt (assuming the lender or creditor doesn’t ask for a personal guarantee) the creditor’s primary source of recovery is the assets of the business itself. The corporate veil protects the personal assets of the business owners such as their home, personal bank accounts and investments. If the business creates some form of legal liability the only legal recourse available to a creditor (in most cases) is to pursue an action against the business itself. This is known as the “corporate veil.”
Generally speaking, the owner(s) of a company or shareholders of a corporation are not personally liable for the company’s debts. There are cases where California courts have allowed a plaintiff to go after the personal assets of directors, officers or shareholders of the corporation to satisfy a judgment against the business or to relieve the debts and other liabilities of the company itself. In order to do so the creditor must “pierce the corporate veil” and demonstrate that the company, LLC or corporation is in fact the “alter ego” of the owners, an not in fact a separate legal entity. The process of how to prevent a creditor from piercing the corporate veil are therefore quite clear: maintain the “corporate formalities” and corporate compliance necessary to demonstrate the entity is separate and make sure the assets and funds of the business are never used for personal reasons. Likewise, personal funds and assets must never be used for business purposes.
Pro-Tip: “according to the laws for decades, including rulings of the Supreme Court of the United States, business entities are like separate legal entities from yourself. They’re actually something that you can turn into a very powerful and valuable asset just by creating it as a business. The biggest example is if you are, ‘Joe’s Pizza,’ then you’re just Joe and you have a pizza place. But if you have an Empire of Joe’s Pizzas all over the country, then your name is branded, then your entity has value, you can borrow against it. You can go to banks, you can go to investors. It becomes a very valuable and important tool. Probably the most important and most neglected tool that a business owner or a business formation person will make sure they get right. So when you think of your business, you create an entity and you create value for yourself and you create protection for yourself.
What are some of the general protections of the corporate veil?
The corporate veil applies to both limited liability companies and corporations and also some other trust and things like that. But if you have a separate business entity, you have something called a corporate veil. And the thinking is if you keep everything separate and you treat it as a separate entity, you don’t co-mingle funds. You don’t fail to keep records. Then if there’s an obligation of the corporation or if there’s no statute saying it goes right to the primary owner, owners, and shareholders, then you are not personally liable for that. And that means you can take more risks in the business place. You can take out loans, you can get vendor contracts, you can get employment contracts, you can do all kinds of things, joint ventures, mergers, all kinds of things in the name of the business. And when you get home, if things go bad, you don’t have to tell the wife, yeah, I lost the house.
What is corporate governance and why is it so important for corporations and business owners to perform and to pay attention to corporate governance?
Corporate governance is maintaining your corporation in a legal and proper fashion, such that you’re in compliance with all the laws of the state of California, so that you may be respected in your corporate form as a separate legal entity. It’s about fairness, it’s about preventing fraud, it’s about doing business in a proper manner, which doesn’t rip off customers, doesn’t damage vendors or lenders. If you maintain your corporation in a proper fashion, keep your minutes, keep your statement of information with the Secretary of State filed, have your meetings and maintain proper records and do business separately, then you should have benefits. You should have tax benefits, you should have investor benefits. You should have benefits of when you want to sell your company. And when someone comes to look at your business, like when we sell a company, we have to come up with something called schedules. Schedules are what we use to identify all the different elements to tell a buyer this is a proper corporation and it’s a safe bet to purchase or to merge with. So all those things. And on top of that, if you comply with corporate governance, you’ll end up doing better in business . I can tell you from my extensive over the last almost 40 years, the companies I see that don’t hold their meetings, that don’t keep records, that don’t refuse to commingle, those companies don’t do as well. The ones that really stay on it and run their business the right way are usually much more successful.” – Dan Watkins, Founding Partner
Commingling of funds and assets is a primary way for any creditor to allege the LLC or corporation is not separate from the individual(s). The experienced business attorneys at the Watkins Firm advise our clients on how to prevent a creditor from piercing the corporate veil and preserving the protections of a business or corporate entity. Are you concerned that corporate formalities such as annual meetings, minutes and procedures are not being followed? Are you concerned about the commingling of assets? We invite you to review our podcast Episode 24 – Corporate Governance as well as the strong recommendations of our clients and contact the Watkins Firm or call 858-535-1511 for a complimentary consultation today.
