How Thick is Your Corporate Veil? Minimizing Personal Exposure for Business Activities
Among other things, investors and entrepreneurs use corporations to limit their liability for business obligations to the amount they have invested in the corporation. This “limitation of liability” feature protects the owners from having to pay out-of-pocket for damages they did not personally cause. The line between whether the “company” or the owner(s) are liable is sometimes so thin that it is referred to as the corporate veil, and a plaintiff suing a corporation’s owners and attempting to hold them personally liable for something relating to the business is said to be trying to “pierce” the corporate veil. These plaintiffs can include accident victims, disgruntled employees, creditors, vendors, customers, business partners, etc. This possibility raises the often looked at issue of under what circumstances will the corporate veil be pierced.
As a general rule, courts will not pierce the corporate veil until the company is found liable for some inequity and the judgment imposed by the Court against it is not satisfied. Once it is determined that the judgment cannot be satisfied by the company because of insolvency or any other reason, the Court will then implement a two-part test to see if the corporate veil should be pierced. First, the Court examines the corporation and circumstances to see whether there was a showing of improper conduct. Second, the Court decides whether the corporation was a “mere instrumentality” or “alter ego” of its owners.
The term “mere instrumentality” has been interpreted to include a company used as the owners’ piggybank without any independent business purpose, and which is functioning solely to satisfy the personal needs of its owners. An “alter-ego” has been described as a corporation with only a few owners who have failed to separate their personal affairs from that of the company.
Following corporate formalities is usually enough to resist piercing of the corporate veil when there is no improper conduct, and even though there may be no practical difference between the company and its owner. In the case of Rashdan v. Sheikh, for example, Sheikh attempted to enforce a judgment against Dr. Rashdan by taking assets from a professional association (“P.A.”) owned solely by Dr. Rashdan. The Court ruled, however, that despite Dr. Rashdan’s sole ownership of Rashdan, P.A., this ownership interest didn’t entitle Sheik to pierce the corporate veil, as the company was not an “after ego” of Rashdan just because he was its sole owner.
Certain Federal standards also exist for assessing whether a corporation is a “mere instrumentality” or “alter ego” of its owners. These are seen as persuasive in Florida’s courts, and include (a) whether the corporation’s financial account is managed for the benefit of the owners or of the corporation, (b) evaluating the ability of the corporation to make its own business decisions, (c) whether there is equal standing between the corporation and its owners or related corporations, (d) whether money is exchanged between the parties informally, (e) whether the corporation acts independently to turn a profit, and (f) whether the parent and subsidiary companies or individuals file consolidated or independent income tax returns. Courts also look for fraud, impropriety, or inequity to third parties on the corporation’s behalf.
In Eagle v. Benefield-Chappell, Inc., for example, the Court stated that improper conduct on the defendant’s part by way of failing to issue stock and keep proper corporate records, standing alone, were insufficient grounds to pierce the corporate veil, and that it must be proven that the company was formed or used for some illegal, fraudulent, or unjust purpose which caused the harm. In that case, however, the deliberate increase of actual costs and the adding of an additional fee, contrary to the terms of a contract between the parties and in furtherance of the owner’s own purposes, led the Court to in fact pierce the corporate veil. In the end, one can certainly glean that a failure to follow corporate formalities and observe the differences between the corporation as an entity and its owners will significantly weaken the corporate veil.
A final point worth noting is that the concept of limited liability for corporate owners and piercing the corporate veil should be distinguished from asset protection, which consists of protecting an individual’s assets (including the stock in their business) from being seized to satisfy claims made against the individual for damages that the individual may have personally caused unrelated to the business. Still, planning to limit business liability and planning to protect assets from personal liability can and should be done simultaneously.