Most small business owners make the mistake of assuming that once they have set up a corporation or limited liability company, they and their personal assets are protected from liability.
As a result, they do not take any further action to sustain limited liability protection. Or worse, they take actions that weaken limited liability protection.
In this guide, we will discuss what limited liability protection is (in other words “the veil”) and how courts allow “piercing the corporate veil.”
For ease, we will use the term “business” interchangeably when discussing the limited liability of a corporation or a limited liability company (LLC).
What Is the Corporate Veil?
The corporate veil is the limited liability protection that stands between a business’s officers, directors, managers, owners, and all their personal assets and the business’s creditors, claimants, and contractual partners.
The legal idea is that a business is its own legal person, with its own rights, duties, liabilities, and assets. Therefore, a business can enter into a contract and open a bank account.
It can also take out a loan or buy real estate. In the alternative, the business is liable for its actions. Third parties can sue the business for its activities, debts, and defaults.
When a business fails, it must answer for its commercial activities and it is liable for damages.
That said, only its assets are subject to the civil claim, while the owners are typically shielded through the business’s limited liability protection.
This is a powerful tool provided by law. Even so, the law asks something of the owners in return. The law expects that the owners will respect the “personhood” of the business. That means:
- Operating the business through its governing documents;
- Using business bank accounts for business purposes only;
- Not borrowing business funds for personal use;
- Not mixing personal funds or assets with business funds or assets (i.e., co-mingling); and
- Not using business assets for personal use (e.g., taking the business truck on a camping trip, etc.).
If you engage in any of the above activities, you weaken the business’s limited liability protection for you and your personal assets.
What Does Piercing the Corporate Veil Mean?
In general, courts are reluctant to pierce the corporate veil because to do so would discourage business enterprise, which often involves assessment of risk.
Individuals are less likely to take on a risky business venture if they and their personal assets are vulnerable.
When that happens, commerce suffers. Therefore, piercing the corporate veil is an extreme measure used in very limited circumstances.
Unfortunately, it most often occurs to small businesses or with a multi-business enterprise operating for a common purpose (i.e., a master business with several subsidiaries).
When a court decides to pierce the corporate veil, it disregards the “personhood” of the business and holds the owners liable for any judgment against the business.
As a result, judgment creditors can seize, sell, or place a lien on an owner’s assets.
The Law: How Is the Corporate Veil Pierced in Texas?
In this regard, Massingill can help. Nevertheless, courts will generally pierce the corporate veil under the following circumstances:
- As an alter ego—the business is a mere tool or conduit of a natural person;
- To prevent the perpetration of fraud—the business is used to enter into a contract it cannot fulfill; and
- Sustaining the business’s limited liability protection would be unjust—preventing money from being reached by a creditor that was transferred from the business to an owner.
Texas does have several other standards under which it can pierce the corporate veil, but the above represent the most common, with the “alter ego” basis being by far the most frequent.
As well, the above standards apply to piercing the veil of a multi-business enterprise. In that situation, when a court holds a subsidiary liable, the judgment creditor may seek to pierce the veil of the subsidiary to reach the master business.
In these cases, the courts look at whether there are overlapping officers, assets, accounts, and operational structures.
If the court finds enough of these contacts between the master and subsidiary, the subsidiary’s veil may be pierced.
How to Preserve the Corporate Veil
We mentioned that many small business owners—once they form the business—start thinking that a corporation or limited liability company, simply by existing, will always protect them and their personal assets from liability.
Usually, this is the case. However, it is responsible business practice and smart personal behavior to take these steps to bolster your business’s limited liability protection:
- Respect the business’s governing document by holding regular meetings, recording minutes and resolutions, and maintaining the business’s state registrations;
- Maintain distinct bank accounts for the business and yourself;
- Engage in strict and frequent accounting of the business’s finances and accounts;
- Do not use business assets for personal use, and do not use personal assets for business use;
- All loans from the business to you or a third party should be in writing and meet minimum commercial standards (e.g., interest rate, payment terms, payment frequency, etc.); and
- With a multi-business enterprise, keep each business separate and distinct with regard to all of the above points.
This list is not extraordinary but rather good and basic business governance and practice. Maintaining these standards consistently will go a long way to sustaining the limited liability protection afforded to you by your business.
How a Business Law Attorney Can Help
Massingill serves as legal counsel to hundreds of small businesses. We have shepherded business owners and their dreams from inception to success.
To do so, we anticipate and prepare for risk through properly establishing businesses and guiding them in governance, operation, and commercial relationships.
Contact us to see how we can help your business maintain its legal and commercial stance.