So you formed a corporation or a LLC for your small business. Think your personal assets are safe from lawsuits or creditors–think again! The law allows a third party to “pierce the corporate veil” to hold the shareholder(s) liable for any claims asserted against the corporation. Under this doctrine, if the third party is successful, the court will regard the corporation as the alter ego of its shareholder(s)–meaning you– and allow a third party to reach your personal assets (such as your house, your car, your investment accounts) to fulfill the corporation’s obligations.
Knowing the general requirements to piercing the corporate veil will help you take the appropriate actions to protect your personal assets from the liabilities incurred by your business. The law provides that in order to pierce the corporate veil, “[f]irst, there must be such a unity of interest and ownership between the corporation and its equitable owner that the separate personalities of the corporation and the shareholder do not in reality exist. Second, there must be an inequitable result if the acts in question are treated as those of the corporation alone.” Sonora Diamond Corp. v. Superior Court (2000) 83 Cal.App.4th 523, 538. In layman’s terms, the party seeking to pierce the corporate veil must show that there is “a unity of interest” between the corporation and its shareholder(s) and that “an inequitable result” will ensue if the corporate shell is honored. Each case is determined based specifically on its facts.
As to the “unity of interest” requirement, the court examines the following factors to determine whether the corporation and the shareholder(s) maintain separate identities:
1. Was the corporation adequately capitalized?
Did you put enough money aside to fund your business and to cover its anticipated expenses? Whether the capital comes from your personal funds, a business loan or private investments, the court will want to see that you have set aside an amount of capital that corresponds to the type and the needs of your business.
2. Are corporate formalities satisfied?
To satisfy strict corporate formalities, you should create and update the corporate bylaws, issue stocks or request a permit to issue stocks, maintain records of all corporate minutes and meetings, hold initial and annual directors and shareholders meeting, elect directors and officers and timely complete any annual filings required by the state of incorporation.
3. The stock ownership picture.
Who owns the majority of the stocks of the corporation? While this factor is not determinative, it is unfavorable with regard to corporations that are held by one shareholder because the sole shareholder has greater discretion to use the corporation as a shell. Because the stocks of small businesses are generally held by one or two shareholders, it is particularly important for such businesses to take the steps explained herein to maintain a separate corporate identity.
4. Commingling issues
Are corporate assets commingled with personal assets? To ensure that the court will not find a “unity of interests” to pierce the corporate veil, you should separate the business’ finances from your personal finances by maintaining separate bank accounts, keeping separate financial records and ensuring that personal and corporate funds are not comingled.
In essence, there should not be a blurred line between the identity of the corporation and that which belongs to its shareholders. If the court finds a “unity of interest,” and that upholding the corporate shell would promote a fraud or injustice, the court may disregard the corporate shell and allow creditors to reach your personal assets.
Anh N. Nguyen, Esq.
Regal Law Office
21151 S. Western Ave., Suite 249
Torrance, CA 90501
**The opinion above is not intended to be legal advice and does not create any attorney-client relationship between its author and the readers**