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The Myth Of The Impregnable Corporate Veil

By Randall K. Edwards

            A while back I was speaking to a man I met at a party.  After the usual pleasantries about the weather and the local college football teams, we got around to what each of us does for a living (isn’t that sort of the way all party small talk goes?)  I mentioned that I was a lawyer and that among the things I handle is asset protection.  The man looked at me with a self-satisfied smirk and said, “I don’t need any of that kind of stuff.  After all, I’m incorporated.”  He then went on to tell me that he knew all about the “corporate veil,” and that not only was he totally protected, but he was pretty sure that anyone who would consider suing him was most probably going to walk away once they found out that they were dealing with a corporation.  The party moved on and he moved away.  It was neither the time nor the place to give my little lesson about what I call “The Myth of the Impregnable Corporate Veil.”  I’ll give it here.

           There are several reasons to incorporate your business … tax advantages, administrative ease, contractual requirements and banking requisites among them.  Of course, one of the most often cited – and most often understood – reasons is asset protection.  The idea is that if one is properly incorporated, the highly touted “corporate veil” will protect your business from your personal creditors and also protect you from your corporate creditors.

            Unfortunately, for many of us – at least the small business owners I often represent – the “impregnable” corporate veil is simply a myth.  Here’s why.

            Let’s suppose that you own a bakery.  You incorporated it as “Quality Hometown All-American Bakers, Inc.” when you first started doing business, and you’ve re-registered your corporation every year when prodded to do so by the annual notices you received from your state’s incorporating authority.  You have a separate bank account for your company, you file your proper tax returns and when you sign contracts for the company – or even just invoices – you usually are careful to sign as the president of the company, and not personally.  One day, there is an accident at the bakery.  A customer’s small child gets away from the customer while you’re waiting on them, darts into the baking area and, quick as a flash, is terribly burned by one of your baking ovens.  While you are still reeling from the accident, you hear that your customer has hired a lawyer and is thinking of bringing a lawsuit.

            Will your “corporate veil” protect you from potential personal liability?  Hardly.

            Consider a few matters here.  If your customer’s lawyer is savvy – and most plaintiff’s lawyers are, regardless of what you may think of the profession – he’ll sue your company and he’ll sue you.  How, you may ask, could he bring me into the lawsuit personally when it’s obvious that any injuries came about as a result of the business?  Here’s how.  As a director, officer and shareholder of the company, you are arguably in a position to require that the company undertake better safety measures.  The plaintiff’s lawyer will argue that you knew or should have known that the bakery was a dangerous place, that you knew that children would be there with their parents and that you were in a unique position to require that adequate safety measures would be taken by the company.  Now, whether these arguments are valid or not, the fact of the matter is that there’s not a court in the country that will simply dismiss the case against you because it was brought against you personally, even though the underlying case arose as a result of the business.  You’re going to be named in the lawsuit, along with your company.  You could possibly be on the hook personally.  In fact, your “corporate veil” may not protect you a bit.  You could be found to be personally responsible for your actions – or your failure to act – having to do with your management or control over the corporation, even if you did everything right.

            But what if you didn’t do everything right?  I have to admit a bias here.  I’ve been practicing law for almost 25 years, and it’s a pretty rare case where I’ve seen a small businessman really consider protecting and preserving the corporate veil in carrying out his business.  Let me tell you what I mean.  If you own your own business, or if you have a position of responsibility in one, take just a minute and answer these questions:  When was the last time I had a corporate shareholders’ meeting?  When was the last time I had a board of directors meeting?  Were they properly noticed?  Were they held regularly?  Could I put my hands on the minutes of those meetings today?  Do I have written and witnessed corporate resolutions for such things as major purchases, including vehicles, equipment and computers?  Have I ever purchased personal items – such as groceries or a family dinner – with my corporate credit card, or with a corporate check?  (I once had a client who was paying his alimony and child support payments from the company’s coffers, and was absolutely flabbergasted when I told him that wasn’t a good idea).  Have I always made clear that when I’m signing a business document that I’m acting only in my capacity as an officer of the company and not personally? 

            If you’re getting nervous about now, there’s good news and bad news.  The bad news is that if you’re out of compliance with the basic corporate requisites, it will make it much easier for a plaintiff to jump through the corporation and hold you personally responsible.  The good news is … well, there really isn’t any good news.  It’s just that you can take some solace in knowing that you’re not alone in failing to take your corporate responsibilities seriously.  It’s pretty cold solace, however, when a court finds that you are indeed an “alter ego” of your company and that you’re personally on the hook for your company’s actions.  The “everybody does it” defense won’t do you much more good in court than it would have gotten you in second grade.

            But, do courts really ignore the corporate veil and find officers, directors and shareholders personally responsible for the corporation’s actions?  Unfortunately, the answer is, increasingly, yes.  There are some states that are worse than others in this regard.  For example, it’s been my experience that a California court may be far more inclined to disregard a corporate entity than would be a court in neighboring Nevada or Arizona, but often the distinctions between those states are more a matter of subtle degree than of principle.  Courts in any state are not hesitant to rip open the corporate veil if they feel that justice will be done that way.

            Now, I don’t want to be seen as the harbinger of gloom and doom when it comes to corporations.  I think that there are great advantages in incorporating some businesses – most businesses, in fact – and I believe that it is always better to build as many legal safeguards around your business as you possibly can.  I simply want to point out that incorporating your business is not the magic bullet you may think it is when it comes to trying to keep out of trouble.

            So, what can you do?

            There are various strategies and tools that you must consider when it comes to diminishing your risks and potential liabilities.  Here are five:

            First, get yourself adequate liability insurance.  If you’re a professional, get malpractice insurance.  If you’re a bricks and mortar business, get a general liability policy.  Get officers and directors’ errors and omissions coverage.  Get adequate vehicle insurance.  Get homeowners insurance.  Get a big umbrella policy.

            Second, don’t be stupid.  By this, I mean, don’t open yourself and your business up to unnecessary risks.  Implement a safety program at your company.  Reward creative ways to keep out of trouble.  Comply with governmental regulations – regardless of what you may think of them.

            Third, be honest.  Courts are far more likely to jump through your corporate veil if they suspect that you’re defrauding someone or trying to cut ethical and legal corners.

            Fourth, figure out a good personal and corporate asset protection and risk management plan.  This will require some solid and smart estate and asset protection planning with the tools that are legally available.  You may need some simple annuity and retirement planning.  You may need something a bit more sophisticated, such as various legal structures like limited liability companies, limited partnerships or domestic or international trusts.  You may require something even more complex, such as accounts receivable equity stripping or charitable trusts.  The point here is to sit with a qualified planner who can take into consideration your unique needs and desires and fashion a program that will be to your best benefit, from a tax and asset protection standpoint.

            Finally, follow the rules.  This means that you must actually carry out all of those annoying corporate duties – have your meetings, notice them properly, adequately document them, keep your corporate and your personal accounts separate, have an up-to-date corporate ledger book, make sure that your by-laws are tailored to your particular business (and not simply something that your lawyer ran off from his word-processing form program), take your responsibilities seriously.

            In the final analysis, the corporate veil may not be the impregnable fortress that we’d like.  On the other hand, it can, when used properly and prudently, provide a wall around the castle.

Randall K. Edwards practices law in Utah, Nevada, California and Arizona.

 

 

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