Most businesses don’t set out to commit corporate fraud and break the law, and you’re certainly not one of those businesses (right?). But you don’t have to intentionally commit a crime in order to weaken your corporate veil and leave your own personal coffers open to the courts, if your business should have to default on a loan.
How the Corporate Veil Works
When you incorporate your business, that corporation takes on a life of its own. Rather than this business being a legal extension of yourself personally (such as with a DBA), the corporation is its own legal entity, able to enter into agreements, take out loans, and execute legal documents.
One function of this is that unlike with a DBA (where the individual owner is directly responsible for debts and obligations), a corporation has another layer of protection between owner and business known as the corporate veil; this corporate veil protects the individual owners of a corporation from being forced to use their personal assets to pay back debts the business might default on.But, contrary to what the media might have you believe, the protection of a corporate veil is not an excuse to run rampant and take out irresponsible loans with no intention of paying them back.
How the Corporate Veil Doesn’t Work
Before your inner George Bluth starts rubbing his greedy palms together, let’s look at a few things the corporate veil won’t do for you.
- It does not protect you in the case of corporate fraud. If your corporation takes out business loans with no intention of ever making good on them, the individuals responsible for that do not get away scott-free. The corporate veil can and will be pierced in any case involving fraud.
- It does not protect you if your corporate records are a mess. If the courts believe you may be commingling your personal and corporate finances, it won’t go well for you if you can’t prove anything to the contrary.
- It does not protect individuals with no discernible corporate responsibilities. If someone is involved in the business and collects a paycheck for their work, you’d better be able to prove that they do perform actual work. You can’t salary someone who doesn’t actually work there.
How to Keep the Courts from Piercing the Veil
It’s not as difficult as you might think to keep your corporation running on the up-and-up, not leaving yourself open to personal liability. Here’s how.
- Follow the rules and regulations of your state. Only you are responsible for your corporation’s compliance with all state and local requirements.
- Have all of the required shareholder meetings—or at least keep a written record of unanimous shareholder actions—and keep good records of those meetings.
- Keep all of your paperwork together in one place. (Some states actually require your formation documents to include the location of your corporate records.) It’s not a bad idea to keep copies at an offsite location as well.
[A corporate kit is a great way to keep your formation documents, minutes, and all other written records secure and together.]
- Make sure everyone involved in the business has a function, and keep records on file for each officer that includes their position, duties, compensation, and any other written agreements.
- Don’t break the law. Any time you do something shady and use your corporation as a cover, chances are, you’re opening yourself up to personal liability.
This is all general information, not to be taken as legal advice. As always, it’s a good idea to consult a corporate attorney (which I am not) to receive advice tailored to your specific situation.
[Read more: “How To Avoid Piercing the Corporate Veil“]