What is the corporate veil?
The "corporate veil" refers to the protection that separates one's personal assets from their business' assets. Piercing the corporate veil removes this protection, and thus makes the individual personally liable for the activities of the business .
When does the corporate veil get pierced?
When you decide to legally setup your business as a corporation or LLC, the business becomes it's own entity. Technically, the business is a "person" in the eyes of the law. Individuals (likely you) still manage the business, but if something goes wrong the individuals' personal assets won't be at risk.
However, the law is very clear that the corporate veil will not protect business owners engaging in dubious behavior. For example, a mobster using his business entity to cover up his crimes. In situations where the corporate veil is being used in a way that is contrary to the "public good", the corporate veil will be pierced, and thus no longer provide protection. Each state has it's own rules for when the corporate veil can and cannot be pierced, however there are a few general guidelines that all states apply:
- knowingly taking on debt when your business is insolvent / has run out of money.
- being involved in fraud or other criminal activities.
What happens when the corporate veil is pierced?
If your company loses it's limited liability protect (aka: the corporate veil no longer applies), creditors and the courts are allowed to seize your personal property to collect on debts. No piece of personal property is safe - your car, home, and other valuable possessions can all be taken to satisfy the debt.
Additionally, you could also face legal consequences if the corporate veil was pierced due to your fraud or illegal activities.
How can I avoid the corporate veil being pierced?
There's a few basic things you can do to avoid this happening: Register your business entity. Whether you're advised to setup your business as a corporation or an LLC make sure the proper documents are filed and you receive confirmation.
- Documentation! All major business decisions, meetings, and purchases should be recorded. This will show that your business is not merely a tool that you (and others) are using to shield themselves from taxation or personal liability.
- Keep business and personal assets separate. The key mistake many small businesses make is conflating their business assets and personal assets. You should take care to keep separate bank and credit accounts for each entity. For example, you wouldn't use a company credit card on your family vacation.
- Don't borrow if your company is insolvent! Business owners who continue to operate a business that is in significant debt are most at risk for the corporate veil being pierced. The policy reason is simple - society at large has an invested interest in ensuring that creditors who loan money to businesses aren't fearful that the business will go bankrupt and the credits won't be able to collect. Imagine if this public policy reason didn't exist - banks and other large financial institutions would likely cease lending, and there would be significantly less business loans being made. Considering companies like PayPal have already topped $1 Billion in small business loans - this could have a detrimental effect on the economy.