For many business owners, one of the main factors in the decision to incorporate is the limited liability protection inherent in a corporate structure; contrary to a sole proprietorship or partnership DBA, the owners of a corporation are not liable for debts or obligations of a corporation.
But, as we’ve learned time and time again from the national headlines, this protection isn’t absolute. Hiding behind the corporate veil as a screen for shady personal dealings is a big no-no, and in cases like this the courts have the legal power to rip that veil down and expose—and punish—the man behind the curtain.
Let’s take a look at what the corporate veil really entails, as well as some of the ways you can guard yourself against losing your limited liability protection if your corporation should find itself on shaky financial ground.
What does it mean for a corporation to be a “legal person?”Obviously, a corporation is not what you might think of as a person (not a biological one, anyway). But a corporation is a legal entity in itself; upon incorporation, it does become a “legal person,” with many of the same rights as you and me:
- A corporation can enter into contracts. These contracts are as legally binding as any contract signed by an adult individual.
- A corporation can open a bank account in the corporation’s name.
- A corporation can bring legal action against another person or corporation.
- A corporation can be sued for many of the same reasons a person can be sued for: reneging on a contract, human rights abuses, and so on.
While a corporation doesn’t have the full legal rights of a living, breathing human—it can’t get married, it doesn’t have a vote, it can’t run for office—it clearly does have a significant amount of legal power.
What does the corporate veil do?
The term “corporate veil” is slightly misleading, as it brings to mind a tangible *thing* when it really refers to an intangible concept. However, the metaphor does bring to mind a good mental picture of this concept: the corporate veil refers to the legal separation between the owner and the business.
In other words, the corporate veil protects you, the individual owner, from having your personal assets seized to pay for the debts and obligations of the business.
But wait—how does this differ from other types of businesses?A sole proprietor can do all of those things too, right? Yes, but the distinction here is that while a sole proprietor—the owner of a sole proprietorship—can do the same things a corporation can do, it’s the owner him- or herself that’s at legal risk.
For example, if a corporation defaults on a loan—provided it didn’t take out the loan under fraudulent circumstances (i.e., with no intention of ever paying it back)—it can declare bankruptcy while leaving its individual owners’ bank accounts intact.
But, on the other hand, when a sole proprietorship defaults on a loan, the owner of that sole proprietorship carries the full responsibility to pay that loan back.
How can I keep my corporate veil intact?
While this list is not comprehensive—each jurisdiction has specific corporate regulations that must be followed—below is a general, very common-sense list of things your corporation should be doing that will help prevent the corporate veil from being pierced:
- Keep accurate and detailed records of your meetings. (Just the actual topics covered and decisions come to, that is; you don’t need to include—nor should you include—a word-for-word account of deliberations. Your officers should be able to deliberate freely.)
- Make sure all corporate officers have an actual role other than collecting a paycheck.
- Keep detailed records of all of your corporate assets, and keep these records completely separate from the personal assets of the shareholders and officers. If money transfers from one to the other, if you’re asked about it later, you’d better be able to explain exactly why and how this was done.
- Take out any line of credit or loan in good faith. Taking out credit with no intention of honoring any debt is corporate fraud, and corporate fraud is the kryptonite to the strength of your corporate veil.
The bottom line: don’t do anything shady with your company that you wouldn’t do if it put your own personal assets at risk, and likely, you won’t be.
[For more information on corporations, take a look at Click&Inc’s business comparison page!]