How Might a Business Owner Be Held Personally Responsible?
Even after you’ve set up a corporation or LLC, you may be held personally responsible for certain corporate debts or actions. Piercing the corporate veil is the legal term for when people are held liable for the activities of a corporation. The owners of a corporation or limited liability company (LLC) can shield themselves from personal responsibility for corporate debts and other legal obligations by separating the firm and their individual lives.
The corporate veneer must have some substance, and the enterprise must exhibit behaviors consistent with its status as a going concern. It takes extra work to distinguish between roles played by the same people in closely-held firms (relatively few shareholders) where everyone knows everyone else. Furthermore, it is common practice for small business owners to divert all profits to their pockets and use company resources for non-commercial purposes.
Juries are instructed to consider if “a unity of interest and ownership such that the separate personalities of the entity and the owner no longer exist and upholding the distinction between the owner and the entity would be an injustice.” In other words, the veil will be penetrated if the corporation or LLC is the person’s “alter ego” and acknowledging the distinction would be unjust or false. It would be hard to list all the steps necessary to ensure that the public does not view the company as an extension of its owner. The topic is critical enough that you need to know how to protect yourself from legal trouble.
Many various sorts of claims might result in personal liability for an LLC member or shareholder, but the most common ones are as follows:
Those resulting from the owner’s negligence, fraud, illegal act, or breach of fiduciary obligation;
2. Contractual claims, in particular, those for which the member has provided a personal guarantee;
3. Obligation to pay back taxes, salaries, insurance, and unemployment benefits owed by an employer;
4. Claims predicated on “piercing the veil” of the LLC;
5. Responsibility for a distribution approved or received in violation of the LLC’s operating agreement or the law governing LLCs.
These allegations have nothing to do with whether or not you set up an LLC instead of a corporation. Shareholders in corporations and LLC members are treated the same way about these exemptions. However, this protection from legal responsibility does not always apply. When an LLC is poorly managed, its members or shareholders may find they are not genuinely shielded from legal action against the company.
Critical Elements Used to Lift the Veil
If you or the other owners have been operating the firm as a legal entity separate from the owner(s) and not as the ‘alter ego’ of the owner(s), the matter may end up in court. But what actions or inactions on the part of the owners show this to the courts? The state court will consider each case’s unique facts and circumstances while deciding whether or not to penetrate the corporation veil. A court may conclude that your company is a facade if they find that you used it to conceal your true identity. Instances of undercapitalization where its significance is made evident are significant. However, this is not sufficient to pierce the corporate veil in the absence of other evidence.
When deciding whether or not to pierce the corporate veil, courts typically take into account the following standard and essential factors:
1. Whether or not the corporation abides by corporate formalities (such as drafting and adhering to the rules and procedures outlined in the bylaws, maintaining meeting minutes and resolutions for shareholder and board of directors meetings, etc.); 2.
Lack of access to company documents;
Not enough emphasis on capitalization. There wasn’t enough money to get the company off the ground when the transactions with creditors or others seeking to break the corporate veil were entered into. Creating a corporation is governed by each state’s legislation. These rules will inevitably specify minimum capitalization amounts or formulae for calculating these amounts. To find out how much is required and to make sure you comply with state law, you need to do some research. Because it never had enough money to back its debts, a lack of capitalization meant the company was doomed.
4. If the corporation’s top shareholders are taking money out of business for their use (e.g., to pay personal expenses, make personal purchases, etc.), or if the business’s assets are being used for the benefit of the significant shareholders;
5. Other officers or directors are inactive, having been appointed by the controlling shareholder but not participating in the day-to-day management of the company’s operations;
Sixth, when large shareholders and the company mix their money and other assets;
7. the company has no assets;
8. Relying on a company to shield you from personal responsibility (often as a shareholder);
Non-issuance of stock and dividend withholding
Tendency to lose track of income and spending (10);
11 forming a binding agreement with another party without any intention of fulfilling its terms;
Not keeping business dealings with outside parties impartial.
These are just some of the most typical considerations the courts make, but you should always behave by them.
Breaking Through LLC’s Corporate Shroud
A member or management of an LLC is not personally responsible for the debts, obligations, or liabilities of the LLC just because they are members or managers of the LLC. Nonetheless, LLCs are not immune to the concept of “piercing the corporate veil,” and LLC members can and have been held personally accountable by the courts. The legal doctrine of “piercing the corporate veil” has been extended to limited liability companies (LLCs) in several jurisdictions, such as Minnesota and Colorado. The notion of “piercing the corporate veil” has been applied to limited liability companies (LLCs) by the courts in other jurisdictions, such as Connecticut, Louisiana, Georgia, California, etc.
Despite common belief, Members of an LLC are subject to personal liability in the same way that shareholders are if a court were to “pierce the corporate veil” of the LLC. A lack of corporate formalities is sometimes irrelevant to the court applying the same broad alter ego analysis utilized for piercing companies. LLC administrative regulations may relax the strict observance of some corporate formalities, but this does not give LLC members carte blanche to do anything they want with the business and forget personal obligations. Most state LLC statutes, for instance, do not mandate yearly meetings or specify notice requirements for meetings and elections. In any case, owners of an LLC running an online business should adhere to the same fundamental advice made to corporate owners.
Owner Participation in Governance Roles
All members, executives, and directors of a limited liability company (LLC) are personally responsible for their criminal activities. In addition, they are always individually accountable for their direct actions or omissions that cause harm to persons or property (i.e., torts), even if those actions were committed during the company’s activity. For example, if you leave a damaged wire exposed as an electrician, forming an LLC will not protect you from liability.
You are still fully responsible for your actions, whether operating a company car or not. You may incur personal liability if you order or approve illegal or harmful conduct to people or their property as a director, officer, or manager. There is a danger of personal liability for any member who takes an active role in the LLC’s or corporation’s operations. This is especially true of any service-based enterprise where the members perform the primary service. If you are an electrician and you accidentally electrocute someone by leaving a wire exposed, your limited liability company won’t help you out. If you are a shareholder, the same logic applies to you.
An organization can be sued for breach of contract if it makes false claims regarding its product or service. The damaged party may sue you for fraud or a similar claim if the LLC cannot fulfill its obligations or pay damages. It’s possible that you still won’t be in the clear if the offender is an employee. If you employed the worker and a reasonable person would not have hired such a worker, the injured party may have a claim against you for negligent hiring.
Philip A. Nicolosi, J.D., is the author of this piece. Phil Nicolosi Law, P.C. is Mr. Nicolosi’s legal practice, and it serves clients in commercial transactions, Internet & technology law, and startup & small business law.
Mr. Nicolosi is a reliable consultant for a wide range of enterprises. Business formation, corporate/LLC governance, regulatory legislation, contracts, transactions, and most other non-litigation business legal issues are all covered. Mr. Nicolosi advises clients on legal matters about electronic commerce and Internet marketing. In addition, he helps tech startups secure seed funding, venture capital, and even an exit deal.
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