Piercing the Corporate Veil

The lawsuit protection features of the corporation will be available only if the integrity of the corporation as a separate and distinct entity, apart from the individual, is respected by a court and by the Internal Revenue Service. In matters involving a lawsuit by an injured party, especially if a corporation has no significant assets, the plaintiff will attempt to convince the court that the corporate entity should not be respected and that the principals of the company should be personally liable. In these cases, the plaintiff is attempting to pierce the corporate veil in order to obtain a judgment against the principals, who may have personal assets sufficient to satisfy a judgment.

There are many reported cases on this topic, and the outcome is usually determined by whether the corporation carries out its business and looks and acts the way a corporation should. If the principals treat the corporation and hold out the corporation to third parties as a separate and distinct entity, the court will usually uphold the status of the corporation and will not find personal liability. However, if various corporate formalities are not consistently observed, the corporation will be disregarded and the individuals may be held personally liable.

One of the major problems with the corporate format for small businesses is that as a matter of course the shareholders, officers, and directors will be named in any lawsuit against the corporation. The plaintiff will attempt to pierce the corporation or will argue some theory to make the defendants responsible. In a significant number of these cases, when there is a judgment against the corporation, the court will disregard the legal protection of the corporation and will hold the defendant shareholders, officers, or directors liable.

Much of the practical protection offered by the corporate form is rendered meaningless by these cases. Sometimes the protection is upheld, and sometimes it is not. This lack of certainty makes business planning—and sleeping at night—difficult. Since the shareholder will almost always be named as a defendant in the lawsuit, even if he is ultimately successful, the attorney’s fees and the costs of defense can be financially ruinous.

There are two solutions to this problem. If you are a principal shareholder or officer/director of a corporation, use a proper asset protection plan to shield your personal assets from the potential liability associated with the corporation. Alternatively, use a Limited Liability Company (LLC)—instead of a corporation to conduct business. We will discuss the LLC in detail, but for now, you should know that an LLC cannot be pierced like a corporation and the members cannot be named in a lawsuit for failure to follow any formalities. It provides the protection against liability associated with the corporation but avoids many of the pitfalls. When considering the best asset protection strategy for your situation, determine whether the LLC is an appropriate form to conduct your business activity.