One of the biggest advantages of forming a corporation or a limited liability company (LLC) is the protection it provides for business owners. In most cases, these entities create a legal separation between the business and its owners, shielding personal assets from creditors and lawsuits.
That protection, however, is not absolute. There are certain circumstances in which a court may “pierce the corporate veil,” which would allow creditors and plaintiffs to pursue the personal assets of the business owners. While it’s an extraordinary remedy, it’s vital to understand what corporate veil piercing is and how to avoid it.
When might a court pierce the corporate veil?
Corporate veil piercing is a legal doctrine that allows courts to disregard the legal separation between a corporation or LLC and its owners, shareholders or members. When that occurs, those individuals may be held personally liable for certain business obligations.
Texas is considered pro-business and provides strong liability protections for business owners. Courts are often reluctant to pierce the corporate veil. However, certain factors may increase the risk of it occurring, such as:
- Commingling personal and business funds
- Failing to maintain separate financial records
- Using company assets for personal expenses
- Using the business entity to commit fraud or deceive investors
- Ignoring required corporate formalities
No one thing will automatically result in veil piercing. Instead, courts generally evaluate the overall conduct of the business and its owners.
One of the most common mistakes business owners make is treating the company account as an extension of their personal finances. To reinforce the company’s separate legal status, it’s crucial to maintain dedicated business bank accounts, accurate accounting records and documented financial transactions.
It’s also essential to avoid fraudulent or misleading conduct. Making false representations to lenders, hiding assets, transferring property to avoid creditors or using multiple entities to shield wrongful conduct increases the likelihood that a court will disregard the company’s separate legal existence.
Forming an LLC or corporation is an important step toward protecting your personal assets, but that protection depends on treating your business as a separate legal entity. A legal professional can help establish appropriate governance practices, draft corporate bylaws and ensure the company remains in compliance with the law.