Forming and properly using a Limited Liability Entity (LLE) creates a fictional “veil” or “shield” between the LLE’s owners and its creditors. In order to set one up for yourself, you'll need to understand LLE's and how they work.
Limited Liability Entities
Virtually every small business should be operated in the form of a limited liability entity (an “LLE”). Common forms of the LLE are:
- limited liability company (“LLC”)
- limited partnership (“LP”)
- limited liability partnership (“LLP”)
The forms of LLE’s available to small business owners vary from state to state, but most states offer multiple LLE structures.
What Is the “Corporate Veil”?
An LLE provides limited liability exposure to its officers, managers and owners. That means that the owners of the business can protect their personal assets from claims brought by the LLE’s creditors.
Generally, the corporate veil protects the business’s owners from personal liability and limits an owner’s risks to the loss of his or her investment in the LLE.
Although some people mistakenly believe that a corporation provides more asset protection than an LLC, this corporate veil protection is available to the owners of every corporation, LLC and LLP.
Let’s consider an example. If a business owner invests $10,000 in her LLC and that LLC incurs a liability far in excess of its income and assets, the business owner may lose her $10,000 investment, but her other personal income and assets would not be subjected to the LLC’s larger liabilities. In this way, the LLC has protected the business owner from the risks associated with operating the business.
Piercing the Corporate Veil
Unfortunately, piercing the corporate veil can be done, meaning that there are circumstances by which an LLE’s corporate veil will not protect a business owner from a creditor’s claims. There are essentially two ways that a creditor can get around or “pierce” the corporate veil:
1. If an owner, officer, manager or employee of an LLE is personally involved in the bad act that results in harm, injury or loss to a creditor of the LLE. For example, a corporate officer cannot avoid personal liability resulting from a car accident that the officer caused, even if the officer is driving a company car on company business.
2. The integrity of the LLE is compromised by the owner’s failure to properly use and maintain the LLE.
How to Avoid Piercing the Corporate Veil
Many business owners properly form an LLE but later fail to take the necessary steps to maintain its integrity. Even worse, many business owners will blur the distinction between their personal affairs and those of the business. The consequences of making these mistakes are that the corporate veil can be pierced, and an owner may then be subjected to personal liability by the business’s creditors.
Maintaining the corporate veil is not difficult, but it does require business owners to complete some simple tasks and stay vigilant. Here is a partial list of tasks that should be completed in order to maintain the integrity of the corporate veil:
1. Never commingle personal and corporate finances. Never pay personal expenses with corporate funds, or vice versa.
2. Company officers and managers should always execute contracts and other company documents in their representative capacity. For example, sign documents like this: “John Doe, as President of ABC Corporation.” In this example, Joe Doe is not signing the contract personally. Rather, Joe Doe is signing for or on behalf of ABC Corporation.
3. If your LLE is a corporation, hold annual meetings of shareholders to elect directors, and hold annual meetings of directors to select officers.
4. Create and maintain a company record book, which should include minutes of all company meetings.
5. Maintain and update the organizational documents of the company. For example, for a corporation, update by amendment, when appropriate, the articles of incorporation, by laws, banking resolutions, and the stock or ownership ledger.
6. File on time any required annual or biennial reports with the Secretary of State.
7. Register all assumed business names with the Secretary of State and appropriate county recorder offices.
8. If your business operates in multiple states, register it in each state with the appropriate state agency or office.
9. Learn and follow any requirements unique to the state where your business operates.
This list is certainly not exhaustive, but completing these basic tasks will greatly help preserve the protections afforded to business owners by forming and using an LLE.