If you are a shareholder of a corporation or LLC, you have likely been told that you are largely shielded from liability for the actions of your corporation or company. Indeed, if shareholders thought they could be held liable for the debts of their company in the event things go sour, they’d probably be much less likely to get involved in the first place.
Although shareholders are generally protected, the possibility of liability does exist, and it is something that all shareholders should be aware of.
Piercing the Corporate Veil
Going after shareholders for liabilities of a corporation is known as piercing the corporate veil. Piercing the veil can happen when an individual attempts to go after a corporation for debts owed, fraud, negligence, or other claims.
If an individual isn’t able to recover from the corporation, usually because the corporation doesn’t have sufficient funds to pay whatever is owed, he or she may attempt to go after the shareholders of the corporation. This usually happens because the individual believes the shareholders have more money and assets than the corporation did.
Courts will only “pierce the corporate veil” in very particular circumstances because shareholders rely on the protections that corporations give them. Situations where piercing the corporate veil may be allowed include:
- When the corporation engaged in wrongful or fraudulent behavior, particularly if the shareholders were aware of, or involved in, such behavior.
- When there is little separation between the corporation and shareholders, such that the shareholders use the corporation like a personal bank account.
- Where the corporation failed to follow proper legal formalities when it was set up or during ongoing operations.
- Where the corporation never had enough funds to operate on its own. This is known as being inadequately “capitalized” and also signals that the business was never really a separate entity.
As these factors suggest, piercing the corporate veil is much more likely when dealing with a smaller corporation or company. Legal formalities are less likely to be followed and the few shareholders of the corporation (perhaps only one or two) are more likely to use the business as their personal asset. Thus, you should be more wary when becoming involved with these kinds of businesses.
The Extent of Liability
Assuming there is a basis for a court to pierce the corporate veil, what does that mean? If a court finds that the shareholders of a corporation can be held personally liable for the debts or claims against that corporation, they risk losing many of their assets, including:
- Bank accounts
- Vacation Homes
With a few exceptions, any assets that could be liquidated to satisfy a claim against a shareholder personally can be liquidated for purposes of satisfying creditors.
However, it is important to realize that innocent shareholders who played no part in the bad acts of the company, its decision-making, or decisions to intermingle funds usually will be spared from liability. So if you are a passive shareholder of a small business not regularly involved in the affairs of the company, or regularly using company funds for personal use, you should be protected.
Stay on the Right Course With The Guidance of Business Attorney Jonathan D. Schmidt
The easiest way to avoid liability, and the threat of piercing the corporate veil, is to structure your corporation correctly from the get-go, keep clear procedures and practices in place, and ensure that all members of your company are acting with honesty and integrity. Iowa business formation attorney Jonathan D. Schmidt can help you to meet these goals and more. For more information, contact us online or at (319) 423-3031.