Many business owners incorporate to avoid personal liability for their company’s financial losses and debts. When a business incorporates, owners and shareholders cannot lose more money than they had invested in the venture. Their personal assets are generally not subject to corporate liabilities. However, when a company does not incorporate and is run instead as a partnership or sole proprietorship, an owner can be held liable for the losses of the business, known as piercing the corporate veil.
It’s important to understand that even when a business incorporates, liability protection is not always absolute. The “corporate veil” can be pierced.
When Can the Corporate Veil Be Pierced?
When the corporate veil is pierced, the owners of a corporation lose the limited liability provided by having incorporated. A responsible party can be held personally liable for the corporation’s wrongdoing. In deciding whether the corporate veil should be pierced, a court will consider whether a company is merely the alter ego of the parent company or shareholders.
While no one specific factor determines when the corporate veil can be pierced, courts consider the following:
- Fraud or deception — Using the corporation as an alter ego to deceive someone can provide sufficient grounds for veil piercing.
- Commingling — Commingling the assets of the parent or shareholders and subsidiary without a proper paper trail is typically considered evidence of an alter-ego situation and can result in piercing the corporate veil.
- Failure to keep subsidiary companies separate — In deciding whether the corporate veil should be pierced, a judge will evaluate whether the parent company held the subsidiary out to be a part of it, instead of a separate corporation.
- Failure to follow through with corporate formalities — A court will look at whether the corporation kept minutes, maintained records, provided notice of meetings, and ultimately stayed on the right side of the corporate formalities rules.
- Failure to capitalize the company adequately due to poor management — Undercapitalization can be a factor that indicates an alter-ego relationship.
If a court determines the corporate veil should be pierced, the personal assets of any parties considered accountable can be seized to pay for the corporate debt. This means that a creditor may seize a house, personal bank account, and any other property of value, to satisfy the debt.
How to Avoid Corporate Veil Piercing
No one specific action a parent corporation avoids having a court pierce the corporate veil. Rather, a company should ensure it is adequately capitalized and comply with the corporate formalities. A company should also have its own bank account and keep its own records. In addition, a company should not have to obtain approval before making decisions in its ordinary business — its own management should be responsible for the daily operations of the company.
Critically, if a parent company lends assets to the subsidiary, the loan should be properly documented between the parties. Documenting intercompany transactions and keeping proper records is crucial to help avoid incurring personal liability.
Contact an Experienced New York Business Law Attorney
If you are facing a corporate liability matter, it’s vital to have a knowledgeable business law attorney by your side who can help ensure your legal and financial rights are protected. Brinen & Associates is committed to providing skillful representation to corporate owners for a variety of business matters, including those involving piercing the corporate veil. Call (212) 330-8151 or send us a message to learn how our New York Business Law attorneys can help.