3 ways to avoid piercing the corporate veil in your LLC (with examples)
As a business owner, you know that the first element of your business framework is liability protection and choosing the right entity.
Most often new business owners choose to form an LLC for this reason.
Suggested reading: LLC's 101: The complete guide for creative business owners
But all too often, we talk to business owners who think that just forming their LLC is enough, and they don’t follow through with the next steps, which are vital to actually ensuring you get the liability protection you desired when you formed the LLC.
Here’s an example of what we mean:
You’ve heard some sort of variation of this scenario: LLCs provide liability protection. If your LLC ever gets sued and a judgment is rendered against you, the judge could pull from your personal accounts, even make you sell your house and your car, in order to pay the judgment, etc.
This is exactly why you, as a business owner, have chosen to protect yourself. (Wise move.)
Not only have you formed that LLC, but you’ve likely also opened up a separate business bank account instead (a key step to liability protection).
You’ve done everything you needed to cover your liability, right?
Not quite.
There’s one crucial step that business owners overlook all the time and that is taking the steps to maintain their liability protection.
And in order to understand what is required to maintain that protection, you need to be familiar with “piercing the corporate veil.”
What is ‘piercing the corporate veil?’
In American law, corporations and LLCs are technically considered entities separate and distinct from the people who founded the business.
Our legal system basically considers them an “individual” with rights. Why does that matter to you? Members of an LLC cannot be personally held responsible for any of the LLC’s assets and liability while it is a formal entity, but when a judge decides the LLC is not in good standing, you lose that protection.
Therefore, it’s crucial to know how to keep your LLC in good standing. Entities like “closely held corporations” and small or single-member LLCs are the most susceptible to this scenario.
So let’s talk about piercing the corporate veil, what it is, examples of it, and how to ensure you DON’T pierce it, thereby keeping the liability protection of your LLC intact.
Piercing the Corporate Veil 101
When your corporation's (or LLC’s) “veil” is pierced, the court considers your LLC an “alter ego” of yourself. This wipes away everything you know about LLC liability protection, leaving you completely on the hook for everything relating to your business.
As you know, you forming an LLC builds protective walls around your business, separating your personal assets from your business assets.
When a court decides to “pierce” a corporation’s veil, they are “lifting that veil” of limited liability, and the single-person LLC can be held personally liable for the business’s debts.
In other words, creditors could go after your home, car, bank account, investments, etc to pay the judgment, and individuals could even be held personally responsible for any fraudulent actions of the LLC.
Piercing the corporate veil examples:
Before a court will pierce a corporation’s veil, they’ll take a look to see if any of these scenarios have been met:
(Please note this is not intended to be a complete list of scenarios; just the most common that occur in our industry.)
1. There’s no true separation between the company and its owners (no operating agreement)
For obvious reasons, this is a big risk that single-person LLCs run.
After all, if you’re the only member of your business, how can you prove a separation exists?
The answer is surprisingly simple: Make sure you have an operating agreement in place.
Not only do you need one “even though” you are the only member of the LLC; you need one especially because you are the only member.
The operating agreement will prove that your LLC is governed and runs just like any other business, which of course proves that it truly is a business.
Below you will find the Single Member Operating Agreement our shop attorney Paige Hulse has drafted which hundreds of creative business owners have used successfully to separate themselves from their businesses in the eyes of the law and maintain their corporate veil protection.
Legal template needed:
2. Commingling funds between your personal accounts & business accounts
This is why you’ll hear attorneys, accountants, and financial people harp on having a separate business bank account so much.
“Commingling assets” can occur when the business owner does something like deposit a check written to your business directly in your personal account or writing a check from your business account to pay off a personal debt, like a car payment or mortgage.
This is such an avoidable issue. Simply open a business bank account, and keep your finances separate.
Better yet, hire a CPA and a bookkeeper to help you track your finances, and make sure everything is in line.
3. Failure to maintain corporate formalities
This is a crucial factor to keep in mind and again can be largely protected by having an LLC operating agreement in place.
An operating agreement will state what is required of the LLC each year, such as:
the number of meetings
admission of new members
distributions of funds, etc.
Keep in mind, you can customize your operating agreement to say exactly what you need and can comply with- and by complying with it, you’re maintaining your corporate formalities.
If you don’t have an operating agreement, your LLC will be automatically held to your state’s default rules, which you may not even be aware of or be able to comply with.
Piercing the Corporate Veil FAQ
with attorney Paige Hulse
How can a single person LLC protect themselves from piercing the corporate veil?
Now that I’ve spent enough time talking about the scary side of the law, I want to talk about the simple ways that you can protect yourself.
You probably already know what the answer is, but protecting your LLC from Piercing the Corporate Veil generally requires keeping one thought in mind: establish your business as a separate entity.
How?
First, open a business bank account.
Second, make sure your LLC has an operating agreement.
It’s truly that simple.
In an effort to avoid Piercing the Corporate Veil scenarios, many banks will conveniently require that you provide your LLC’s operating agreement when you open up your bank account.
The operating agreement acts as the cornerstone in proving that your LLC is a separate entity, upon which all other factors are built.
As I mentioned, this operating agreement does not need to be an extensive, wordy document. It simply should cover what I would call the essentials of your business: all of the information from your articles of organization, as well as the name of the member, how much capital you’re initially investing into your business, how debts and assets will be distributed, how new members can be added, etc.
You can find a template for a single-member LLC operating agreement here that you can start using today.
In addition to the simple steps listed above, keep these factors in mind to help protect yourself from Piercing the Corporate veil:
more piercing the corporate veil do’s & don’ts:
Don’t commingle your funds. Decide now that you won’t use your business funds for personal use without first cutting yourself a paycheck.
Do make an initial investment into the LLC when you’re opening up your account.
Do follow all of the rules listed in your operating agreement.
Don’t sign as a personal guarantor of any of your LLC’s debts.
Do be conspicuous about the fact your LLC is an LLC - put it on your website, your contracts, invoices, etc.
Don’t engage in any fraudulent or illegal acts with your LLC.
Do make sure you’re signing all of your contracts properly
And finally let’s go through a few common Piercing the Corporate Veil questions we receive, including a little explainer on that last point, signing your contracts properly.
How do I sign contracts as my LLC?
We’re so glad this question is asked because we often see business owners, especially business owners whose names are the same as their business names, signing agreements incorrectly.
You want to sign in the following structure:
Your name, your designation within the company (eg. owner, manager, etc.), LLC name
So let’s say your name is Mary Johannesson, your title within the company is Founder and your company name is Johannesson International LLC.
You would then sign as follows:
Mary Johannesson, Founder, Johannesson International LLC
And here is an example of how your “Intro” paragraph could read, both if you’re an LLC and your client is a person, as well as if you’re an LLC and your client is also an LLC.
Option 1:
If signing between an individual and a business (ie, if you have an LLC, and your client is signing as an LLC)
This DJ Services Contract (“Agreement”) is entered into on ___________(day) of ___________(month), __________(year), between John Doe, of 123 John Doe Ave, Dallas, Texas, 54343, referred to as “Client”, and The Creative Law Shop, LLC, an Oklahoma Limited Liability Company, having its principal place of business at 123 Creative Law Shop Lane, Tulsa, OK, 78799, (referred to as “DJ Company Name” or “DJ”). DJ Company Name and Client are collectively known as the “Parties”.
Option 2:
If signing between two businesses (ie, if you’re an LLC, and your client is an individual)
This DJ Services Contract (“Agreement”) is entered into on ___________(day) of ___________(month), __________(year), between John Doe, LLC, a Texas Limited Liability Company, having its principal place of business at of 123 John Doe Ave, Dallas, Texas, 54343, referred to as “Client”, and The Creative Law Shop, LLC, an Oklahoma Limited Liability Company, having its principal place of business at 123 Creative Law Shop Lane, Tulsa, OK, 78799, (referred to as “DJ Company Name” or “DJ). DJ Company Name and Client are collectively known as the “Parties”
Can I use my personal email address to buy business things in my business? Will I pierce the corporate veil if I do?
Yes, you may use your personal email address to purchase items in your business.
Of course, getting a business email address is advisable from a looking professional standpoint in the eyes of your clients, but from a piercing the corporate veil perspective, this would not be a problem.
Do I just need separate bank accounts? Or also separate PayPal, credit cards, etc.?
This is a fabulous question and we’re so glad business owners ask us this because the answer is yes!
You will indeed also want separate credit cards, PayPal accounts, Wise accounts, etc. to make as clear a statement as possible that you are indeed running the business as a business.
This comes back to the whole commingling funds issue. If you use your personal credit card to pay for a business expense, then pay off the credit card from your business account, it all starts to get very murky from a legal perspective, not to mention, HIGHLY confusing for your accountant or bookkeeper to keep track of.
Also, most business owners don’t tend to want to give their bookkeepers access to their personal bank accounts and credit cards as well for privacy reasons. So when you separate them you’re both protecting your LLC and it’s liability protection and protecting your personal assets from your bookkeeper’s eyes.
legal template mentioned:
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