A common misconception business owners have is that their personal assets are always protected when their businesses are sued because business entities provide “limited liability” to their shareholders. Many business owners assume that their personal assets (their home, vehicles, personal accounts, etc.) will never be at risk if their business is sued or files for bankruptcy. This is far from the truth.
While it is true that many business owners can and do enjoy these protections, the reality is that business owners can lose that insulation if they fail to honor corporate formalities. There are many cases where a business owner, shareholder, investor, or member could be held personally liable and stand to lose his/her personal assets. This situation where a business owner is held personally responsible is known as “piercing the corporate veil.” In essence, the courts will “pierce” or disregard the legal separation (i.e., the “veil”) between the shareholder and the business entity.
There are a number of scenarios where a court would “pierce the corporate veil.” We cannot go into all of them here, but a common situation is when a business owner fails to honor “corporate formalities.” Corporate formalities require shareholder meetings, directors meetings, minutes, consents, issuance of share certificates, and proper voting and management protocols, among other things.
For example, business owners often do not execute bylaws or operating agreements. They often neglect to hold meetings or vote or issue share certificates. Many think they do not have to because the business is small, but they do so at their peril.
Another common misdeed is “commingling”, or failure to separate personal assets, like bank accounts, payment cards, tools, vehicles, and financial instruments, from those belonging to the business. For example, it is “commingling” to use a business credit card to pay for personal expenses, or to use a personal bank account to pay office rent. Another example is putting a customer’s payment in a personal account.
For the sake of further illustration, let’s look at a fictitious scenario of what not to do.
Suppose David, the only shareholder of a corporation that runs a factory, routinely uses corporate accounts to pay for his home mortgage, family bills, and leisure activities. It is a small business; he calls all the shots, and he is the only boss and manager. He uses the corporate checking account as if it’s his own personal checking account. In addition, he sometimes uses personal funds to pay for business utilities and employee payroll. David thinks these practices are normal since the former owners of the business (his parents) did the same thing. However, by “commingling” his business and personal affairs, David is exposing himself to direct legal liability if his company is ever sued.
David has also never held any shareholder or director meetings, never kept records of director or officer elections, and never drafted bylaws. David figures that, since he’s the only owner, boss, and manager, he does not need to do these things. But his unwillingness to honor these corporate formalities exposes David to personal liability.
In the eyes of the law, the distinction between David and the company can be ignored. David could be held directly liable as a defendant, even though he regards himself as merely a shareholder. As a result, his personal assets could be treated as if they were business assets.
David would have been well advised to immediately establish clear separation between himself and the business – new, separate bank accounts; clean, professional accounting; and an updated corporate book, among other things.
The above examples are just that, examples. Business owners face innumerable risks, so they should ensure that their businesses insulate them. It is simply too risky otherwise. Experienced Castleton attorneys are ready to help. Castleton can help you use the corporate tools that are there to help protect you.
For over 30 years, Castleton Law Group has provided legal counsel to business owners of small, medium, and large-scale companies, whether they are corporations, limited liability companies, sole proprietorships, partnerships or other business ventures. Whether you have been served with a civil complaint or an unhappy employee is making legal threats, a knowledgeable attorney can help ensure your business entity minimizes your exposure to personal legal liability. Castleton can provide you with the best possible legal representation.
Castleton Law Group
info@castletonlaw.com
(626) 810-9300
17800 Castleton Street, Suite 630, City of Industry, California 91748