Maintain the Corporate Veil of your LLC.

Maintain the Corporate Veil of Your LLC

Forming an LLC is the first step toward avoiding personal responsibility in company, but it is not the last step. Discover how wise company owners may keep minimal liability protection (“the corporate veil”).

What exactly is the Corporate Veil?
How to Keep the Corporate Veil?
Understand the Corporate Veil’s Limits

What exactly is the Corporate Veil?

The general norm is that business organizations, such as LLCs, shield its owners from personal liability for the obligations incurred by the firm. In the context of commercial entities, this protection is sometimes referred to as the corporate veil.

However, registering your company as an LLC is not enough to secure your company’s limited liability protection. When an LLC’s creditor is not paid, the creditor may sue the business’s owners, claiming that they are personally accountable for the company’s obligations. This is referred to as penetrating the corporate veil. Creditors may be successful in these attempts if and only if:

The business is badly undercapitalized.
In their commercial dealings, the corporation and its owners did not retain distinct identities.
The company’s activities were deceptive or illegal.

How to Keep the Corporate Veil Alive

There are a few principles that company owners should follow to keep the corporate veil intact:

1. Have Enough Start-Up Capital

If the company never had enough capital to meet its obligations, creditors would claim that it was never sufficiently distinct or independent from its owners to give birth to a corporate veil. To prevent this accusation, it is critical to make a suitable first investment in the firm when launching it.

What does this imply for you and your company?

Money is sometimes scarce when starting a new firm, but every company must decide how much capital is realistically required to meet its early costs and responsibilities, including payments due to creditors and possible liabilities to third parties. Maintaining solvency—having more assets than liabilities—in the early stages of your organization minimizes the likelihood of a successful veil piercing. Determine your financial possibilities and if you need outside investment.

2. Financial matters should not be mixed.

The firm should have its own bank account and credit card, as well as conduct separate transactions from the proprietors. Individual owners should not use the company’s money for personal reasons (for example, paying home cable bills) unless the transaction is properly documented as a loan or a draw. If the firm requires extra cash and the owner desires to contribute, the donation should be recorded as a capital contribution, with proper paperwork provided at the time of the transaction.

How do you maintain compliance?

The following stages aid in the separation of personal and company finances:

Create a specialized business bank account as well as a dedicated business credit card so that the company’s transactions are kept separate from the company’s owners’ activities.
Keep a book of accounts to track company spending.
If the owners must contribute money directly, record the transaction using a formal agreement between the owner and the LLC (such as a promissory note) and a supporting resolution from the LLC allowing the transaction.

3. Correctly sign

The company’s business dealings should be conducted in its name, with the company as the named party to any contracts and the individual signer clarifying below the signature line that they are signing for the company—for example: John Smith, as Authorized Member of ABC LLC, for and on behalf of ABC LLC. This reflects the signer’s name, authority / title, and the company for which the signature is made.

So, what’s the big deal?

The manner in which you sign papers on behalf of the firm must represent the fact that the company is distinct from you as an individual. If you sign a signature line with your name beneath it in a corporate contract, are you signing for the firm or for yourself individually? Maintaining this distinction will assist to establish on an ongoing basis that the business is distinct from you and that you are not personally liable for the firm’s obligations.

4. Business documentation

Meetings of the business, if required by the LLC’s operating agreement, should be recorded in official minutes kept in a professional manner with the firm’s records. Resolutions signed by the members should represent the company’s decisions. These activities are sometimes referred to as “corporate formalities,” although the phrase “formalities” may be deceptive since it implies that the tasks are not required or are “just formalities.” However, in the context of maintaining the corporate veil, this paperwork is significant and necessary.

Why is this required?

In your daily life, you do not need to record your choices; it is sufficient that you understand why you made specific actions and retain that knowledge. However, forming an LLC creates a different entity—a separate “self”—apart from you and your thinking. Because the corporation does not have a brain to recall the decision process and logic for acts, such things must be documented on paper. This “paper trail” is critical for preserving the company’s liability shield—the corporate veil—because it demonstrates that you regard the company’s operations as distinct from your own.

5. Keep your LLC active.

Keep track of state filings

Failure to submit an annual or biannual report with the state of creation in certain states might result in the involuntary dissolution of your LLC. If the state dissolves your LLC, the company owners lose their limited liability protection. Find out what state filings are necessary by selecting your state from the list below.

Purchase Commercial Insurance

Creating the corporate veil by forming an LLC or other company structure isolates your commercial operations from your personal assets. The main advantage of this separation is that if your company is sued, your personal assets (such as your house and savings account) are safeguarded.

Understand the Corporate Veil’s Limits

Even if the firm and its owners completely retain the company’s independent identity, there are several instances in which the company’s owners may become accountable to creditors. These are some examples:

1. Obligations to provide personal guarantees

Creditors sometimes need the company’s owners to sign a personal guarantee of the company’s commitments, such as when signing a commercial leasing arrangement or a business loan agreement. Be aware that a personal guarantee is a voluntary commitment to be accountable for the business debt at issue, which is essentially a voluntary surrender of the corporate veil safeguards.

What exactly is a personal guarantee?

This is any guarantee made by you personally to be personally liable for an LLC debt or obligation. These are occasionally included in contracts as distinct paragraphs, or they might be an addendum or a new document entirely. Read them carefully and ensure that you understand them! By signing a personal guarantee, you essentially waive the corporate veil safeguards. It may make great commercial sense to do so, and it may be required in certain cases as a matter of negotiation, but you should consider this option carefully each time it arises.

2. Personal liability for wrongdoing or negligence

In rare cases, courts may rule that individual members, even if operating on behalf of the corporation, are personally liable for their own conduct or negligence, regardless of the corporate veil. If, for example, a member irresponsibly drives a delivery van and injures a pedestrian, that member may be held personally accountable. The corporation may also be held accountable for any resultant damage.

Why are you directly responsible?

It is commonly claimed that business owners wear “many hats,” and you periodically wear your “owner” hat, which allows you to make decisions about company matters. Then you make a personal phone call while wearing your “unique” hat. And so on. You wear both hats when interacting with the world—driving cars, operating machines, transporting equipment or stock, and so on. In other words, you are both a company owner and a person. If you cause damage or injury while wearing both hats, the actions you took may be used to hold your company and you personally liable.

3. Tax responsibility

Members of limited liability corporations are individually accountable for any taxes incurred as a consequence of business activities. If they are “responsible individuals” who managed the firm’s money and capacity to pay the company’s bills, they may also be personally liable for some corporate taxes (for example, certain state and federal withholdings for workers).

What, I’m personally liable for the LLC’s taxes?

Yes, depending on the taxable jurisdiction, you may be personally liable if you are a “responsible person” for the company’s finances. To protect yourself, you must properly account for business transactions and submit any taxes owed to the different taxation authorities by the deadlines. It is not sufficient to just pay a payroll business without any follow-up or proof that the payroll company performs its job and pays the money to the government on your behalf. Finally, if you are in charge of the company’s finances, you may be personally liable for the payment of the company’s taxes.