Corporate Veil

Once you incorporate you have created a separate and distinct legal entity. You and your new business entity are granted rights by state law and you can enjoy the many benefits of being incorporated. This comes with some administrative formalities in order to make sure your incorporation is going to serve you when you need it the most. Maintaining your business entity is simple, there are a couple critical steps that maintain your corporate veil.

Once you incorporate you have the protection of the "Corporate Veil". In a legal definition this is a perspective from a liability standpoint that your company is solely liable for its own debts and obligations and its owners are sheltered from them. This comes into play when a creditor challenges your corporation's separate existence in order to seek satisfaction from the company owners for business obligation. There are several ways that the corporate veil is pierced and we will cover them here so that when you incorporate your business you can maximize its legal protection.

Strengthening The Corporate Veil
We'll be talking about some examples that can be backed up with case law that clearly show when the corporate veil has protected the owners of a company from business obligations. Simply incorporating isn't enough, you must operate your business separate from those who own it. This isn't very difficult and simply following basic guidelines and procedures can make all the difference in the world after you incorporate.

Proper Organization: This example is the actual act of incorporating your business. Obviously this should be done properly. When you incorporate your business in your state, simply submitting your articles to the Secretary with state fees isn't enough. Depending on the form of business you are incorporating, there are some fundamentals that need to be in place. For corporations, issuing stock helps separate the identity of the owners and the business. Keeping records of organizational meetings of the owners and maintaining those on at least an annual basis is a state requirement. If a court sees a defective incorporation, this could expose the owners of the business, however if good faith was shown on many other aspects and only a single point was found to be incorrect, there could be some liability protection. This will depend on other formalities and whether or not those are defective as well. In the case that the business was incorporated and organized properly with an exception of a minor formality, a court could be favorable to allowing separate identities to apply to the case. It is necessary to incorporate your business correctly, organize and operate your company separately through administrative formalities.

Signing of Contracts: If you sign a document with only your name, it may not matter that you incorporated. A contract with its terms, signed by its parties as individuals means that the contract is between the individuals. If your business in incorporated and the contract is with the business entity, whoever signs it must place the title and entity name below their signature. For example signing a contract with "John Doe, President - My Own Company, Inc" makes it clear that the contract is agreed to and executed by the president on behalf of the business. If a creditor takes a contract to court with an individual's name and signature, then that creditor can pursue the signature authority. This is referred to as the corporate instrument. Once you incorporate, always execute agreements, clearly as between the company and the other party.

Separate Status: Once you have incorporated, you created a new legal person and only by the actions of the business operators, does this separate status get compromised. A creditor will attempt to show a lack of separate existence and pursue the owners' personal assets for satisfaction. A court will test the separate existence by reviewing corporate records and seeing if the formalities were abided by as well as reviewing financial records to ensure that there was no co-mingling of funds between the incorporated entity and the owners. Another formality here would be under capitalization, this happens when you incorporate a business with insufficient capital to satisfy business obligations agreed to. If this is the case, the court can find that the instance of the company was created for this purpose and this would appear to be fraud.

State Requirements: Every incorporated business needs to follow some formalities. State's require that an annual report, or statement of information be filed on the anniversary of the incorporation. This is simply a statement of who the officers, directors and sometimes shareholders are and legal business addresses. If this formality is overlooked, your standing with your state of incorporation could be revoked. This is probably the easiest formality and accompanied by a nominal fee.
As you can see the corporate veil and protection offered by incorporating can be compromised in the event that the company was improperly incorporated, misrepresented in an agreement or operated without separation between the business and those who own it. These play a very important role in running your business after you incorporate.

Piercing the Corporate Veil
If the time ever comes where a claim against your incorporated business is greater than the assets of the company, your corporate veil is the only protection you have. This will be initiated by the creditor, who must file suit against the company owners and request that the court impose liability on the owners, personally. In general there are two methods the creditor will use to pierce the corporate veil.

Alter Ego Theory: This goes right back to separate existence. After you incorporate, operating your business as a separate entity can void this theory. If you treat your incorporated business as separate and distinct entity from its owners, your creditors will be unable to pursue using this theory. This can be as simple as a shareholder paying a personal bill with a company check. To avoid this, make sure that if you need some extra money, declare it through a shareholder dividend, or distribution. The more detailed your records are, the harder this theory will be to pursue.

Undercapitalization: This basically is fraud. If you incorporate a business with insufficient capital in attempt to defraud creditors, then your corporate veil can be pierced. If that was the basis for incorporating your business, then you probably didn't recognize any of the other formalities either. Most small business owners under estimate the amount of funds necessary when they incorporate their business. Its prudent to have a solid plan to get you up and running.

In summary, and for the sake of this topic, we'll assume that you plan to incorporate your business properly and are eager to reap the benefits of being an incorporated entity. Simply keeping things separate, documenting important actions and decisions and keeping company funds, company funds, and personal funds, personal funds, you can avoid almost all of the creditor theories on how to pierce the corporate veil. It is difficult for a creditor to do so, however they will know what to look for and where most business owners go wrong. Still courts are very observant on the big picture and if your business is incorporated and operated properly with possibly a minor formality oversight, you may still benefit from limited liability.

Next Section: Incorporating and Management Structures