One of the main reasons business owners decide to form a company in the structure of a limited liability company (LLC) or corporation is so they can avoid personal liability for business debts, if the business is unable to meet its obligations. However, there are situations in which courts will hold the owners, members or shareholders of an LLC or corporation personally liable for these debts, a circumstance known as “piercing the corporate veil.”
This situation has occurred more frequently in recent years after the economic downturn of 2008-2009, when business owners were either struggling to keep their companies afloat or deciding to shut down operations. Unpaid creditors may sue to “pierce the corporate veil” and hold these owners responsible.
The following are some situations in which courts may agree to pierce the corporate veil:
- There is not a true separation between owner(s) and company: If the owners do not maintain a true legal separation between their personal finances and their business, the court could determine the LLC or corporation is invalid—and just an alter ego of the owner. In this situation, the owners would be personally operating the business as if the LLC or corporation was not in place. An example would be owners paying personal bills from a business checking account.
- The company was engaged in fraudulent or illegal practices: If the business owners recklessly borrowed money and then lost it, made various deals knowing the business would not be able to meet its payments or otherwise acted in a dishonest or reckless way, a court could determine the business owner was guilty of fraud. As a result, the owner would not be protected by limited liability through a corporate structure.
- The creditors suffered losses in an unjust manner: If someone who was engaged in business with the company had unpaid bills or a court judgment and there were other factors at play (such as those noted above), a court may pierce the corporate veil to correct the injustice.
Factors to consider when piercing the corporate veil
A court will take a number of factors into account when deciding whether to pierce the veil. These include the following:
- Whether the business was engaged in some sort of fraudulent behavior
- Whether the business had failed to follow formalities associated with a corporation
- Whether the business was inadequately capitalized
- Whether the business was completely controlled by either one person or a small group of people
Closely held companies are far more likely to lose their limited liability status than larger companies, as they are less likely to observe what are known as “corporate formalities.” These include annual shareholder or directors’ meetings, keeping accurate records, adopting bylaws for the company and ensuring those bylaws are followed by everyone in the organization.
For more information on “piercing the corporate veil” and how to best protect both your business and personal interests, meet with a dedicated corporate law attorney in the U.S. Virgin Islands.
Attorney J. Nash Davis, is an Associate in the Corporate, Tax & Estate Planning Practice Group at BoltNagi, an established and trusted corporate planning law firm serving a wide range of businesses and organizations throughout the U.S. Virgin Islands.