A limited liability company, or LLC, is a corporation that combines some corporate advantages with the tax flexibility of a partnership. The LLC has the benefit that none of its members are liable for any obligations incurred by the business. Members of an LLC may be held liable for the obligations of the LLC in the event of litigation or bankruptcy.
An official court ruling that the company’s LLC status is a fraud is known as “piercing the corporate veil.” When a court reaches this determination, the LLC status is lost, and the owners’ private assets are open to being claimed by creditors. According to this idea, corporate owners are also personally accountable for company debts.
Why Would an LLC Status Be Removed from a Company?
When the court concludes there is no meaningful distinction between a person’s financial obligations and the financial liabilities of the corporation, the company’s corporate veil is destroyed. For instance, an owner may utilize personal funds to keep a business solvent financially, but doing so exposes the owner to personal debt.
Why Should We Pierce the Corporate Veil?
The proprietors of a limited liability company (LLC) or its stockholders in the case of a corporation are not considered to be the legal “person” that a corporation is, according to the law. A corporation or LLC is solely responsible for all debts and other responsibilities under the law. The obligations and liabilities of the corporation or LLC are not held against the owners or shareholders personally.
For instance, if a case is filed against a corporation, the officers and stockholders cannot be named as defendants. They are not responsible for the corporation’s legal obligations.
When a court removes the shareholders’ or owners’ immunity and holds them personally liable for the debts and liabilities of the corporation, this is referred to as “piercing the corporate veil.” If a court lifts the corporate veil, it treats the corporation as if it were not one and allows creditors to pursue shareholders or owners to collect outstanding debts and other liabilities.
The most frequent instances of piercing the corporate veil are smaller, privately held business entities, like close companies or LLCs. These kinds of corporations have few stockholders and few assets. A court might lift the corporate veil if upholding the corporation’s separation from its shareholders will encourage fraud or another unfair outcome.
Because so many shareholders have no real influence over how the company is run, a sizable publicly traded firm has never had its corporate status ignored.
Also in favor of keeping the corporate veil for shareholders are the substantial mandatory paperwork needed to float the shares on a stock exchange. Large, publicly listed companies hardly ever operate informally, which would allow for piercing the corporate veil. Most corporations have in-house attorneys who can offer daily guidance on conducting business ethically and reducing risk.
Why Do You Need to Break Through the Corporate Walls?
A benefit of creating an LLC is typically limiting the owner’s liability for outstanding obligations. Normal limits on a creditor’s ability to sue a firm for unpaid debts would be a claim against the company’s assets. Creditors may breach the corporate veil in order to seize the LLC’s owners’ assets if the LLC is unable to pay its debts.
How Can the Corporate Veil Be Peeled Away?
You might wish to attempt filing a lawsuit to get reimbursed if you’ve given a business goods or services but haven’t received payment. However, it could be challenging or impossible to obtain payment from the company itself if it has ceased operations, liquidated, or been dissolved and has no assets. However, the old company’s owners might still retain assets; therefore, piercing the corporate veil to get paid might be the next sensible move.
When deciding whether it is appropriate to pierce the corporate veil, courts frequently consider several elements. If you ever find yourself in a scenario like this, you might want to discuss the best course of action with an experienced business attorney.
Courts frequently take the following factors into account:
- Whether the LLC committed fraud;
- Whether the LLC violated corporate procedures or company rules;
- Whether the LLC was adequately capitalized;
- Whether one person or a small group of people who are closely related to one another were in total control of the company; or
- Whether owners used company funds for business expenses or personal expenses; or whether owners used both types of funds.
The court might conclude that the LLC was not truly a separate business with the capacity to stand on its own if it was not properly capitalized and never had enough money to operate independently (and thus an extension of the owners).
When Will the Corporate Veil Be “Pierced” by the Courts?
Courts may order an entity’s owners, members, or investors to bear the following risks personally:
- If there is no distinction between the owners and the business.
- If the owner or owners made business dealings carelessly. This encompasses taking on debt and losing it, acting dishonestly, or cheating companies.
- If the company or enterprise lacks sufficient capital.
- If a company or enterprise violated its own formalities and rules
- If bills or an unpaid judgment are left for creditors.
Since state law governs piercing the corporate veil, judges in other states would weigh these issues differently. Some state courts may give certain criteria more weight than others.
To pierce the corporate veil in Texas, a plaintiff must demonstrate an actual fraud that was committed largely for the direct advantage of an LLC member or corporate shareholder. In a case reported to have occurred in Texas, a real estate broker created a new organization and transferred assets from an older company that had been sued to prevent the older company from having the resources to pay any judgments. Because there was insufficient proof of real fraud, the court declined to pierce the corporate veil.
In many states, given these circumstances, a court would pierce the corporate veil to make the new company’s assets available to fulfill any judgment against the previous one, whose assets had been stolen.
A knowledgeable business attorney in the state where a business is located should know how the courts perceive the relevant issues.
Will it be Simpler to Persuade a Judge to Invalidate an LLC Status for a Small Business?
Because small businesses are more likely to operate as the alter egos of their owners, shareholders, or members, courts are more likely to breach the corporate veil of a small business. Small businesses frequently operate without sufficient money or following legally needed LLC corporate formalities.
Once again, corporate formalities are measures a firm does to guarantee the LLC functions independently from its members and in a manner that reflects a true business. Regular board meetings, keeping corporate and personal money separate, and generally conducting business as though the owners and the company are separate entities are ways a firm can maintain its independence from its owners.
A court will likely perceive an LLC or S corporation as a sham corporation rather than one that is legal in its operations if these formalities are not followed.
Are Big Corporations Exempt from Losing Their LLC Status?
When owners or directors establish subsidiary corporations that are effectively phony corporations set up to help the parent, courts may be able to pierce the corporate veil of a huge corporation. To protect the parent business’s assets from a debt it wishes to avoid, subsidiary corporations frequently transfer debts from the main firm to the subsidiary.
Courts may occasionally lift the corporate veil to make the parent accountable for the subsidiary’s debts. When a parent corporation is asked to be held accountable for the debts of a subsidiary, the same criteria that a court uses to determine whether to hold owners or shareholders accountable are also applied.
The court will scrutinize the parent and subsidiary companies’ interests to see if they are actually distinct. The court is more likely to break through the wall of separation if they aren’t. Again, a court is likely to break the curtain of separation between the two entities if circumstances exist to show that treating the two entities as separate would result in unfairness.
Should I Consult a Lawyer if I’m Accused of Cutting Through the Corporate Veil?
Yes. If you have a significant legal issue with a corporate business, you definitely want an experienced corporate lawyer representing your interests.
