Piercing The Corporate VeilDecember 18, 2013
Many legal protections are available to protect stockholders, investors, business leaders and business owners from liability related to operating a business. One of these protections is the ability of an owner to form a corporation or limited liability company (LLC). Although corporations and LLCs are designed to protect the owners from personal liability for business debts, there are times when these protections can be removed. This is often referred to as “piercing the corporate veil” and it is one of the most litigious areas of corporate law.
What Is Piercing The Corporate Veil?
In the United States, corporations and LLCs are viewed as legal entities, separate and distinct from the business owners and managers or people who created the business. One of the biggest advantages of setting up a corporation or LLC is the fact that it limits the owners’ personal liability for business debts. This distinction between owner and business is often referred to as a “veil” and the veil protects shareholders from individual liability for the actions of the corporation.
“Piercing the corporate veil”, then, is when a judge rules that the owners cannot be held separate from the business and are liable for all business debts. If the corporate veil is pierced, corporate creditors are able to extract payment from the owners’ personal assets. In addition to the business owners, liability could be assigned to officers, directors or shareholders.
When Courts Will Pierce The Corporate Veil
Piercing the corporate veil is allowed in Colorado, though justifiable circumstances must exist for a judge to allow it. There are three separate determinations that a court must make before piecing the corporate veil.
Is the business entity simply the alter ego of the owner or shareholder? The Court must determine whether sufficient legal separations exist between the business finances and the personal finances of the owners or officers. If there isn’t suitable separation, a judge could find that the business is not being operated as an LLC or corporation and the legal protections provided by such business incorporations are will cease to exist.
Courts in Colorado look at a number of factors to determine whether or not there is
suitable separation, such as:
- Is the corporation operated as a distinct business entity?
- Are funds and assets co-mingled?
- Have adequate corporate records been maintained?
- Did the nature the business’s ownership facilitate misuse by an insider?
- Is the business thinly capitalized?
- If the corporation is used as a “mere shell”
- If shareholders disregard legal formalities; and
- If corporate funds or assets are used for a non-corporate purposes
Were the company’s actions purposely fraudulent? The Court will examine whether or not the corporation was used to knowingly commit fraud or defeat a rightful claim.
If the company’s creditors suffered an unjust cost as a result of the owners actions. If the Court determines that lifting the corporate veil can restore the losses suffered by creditors, a judge may order the veil to be pierced. In order for this to happen, the judge must be certain that an equitable result will be obtained by piercing the veil and by holding owners and/or shareholders responsible for the liabilities of the company.
Smaller Companies Run High Risk Of Corporate Veil Piercing
Some companies are more at-risk than others for corporate veil piercing. Notably, smaller corporations have a higher risk of veil piercing than larger, publicly traded companies. Smaller corporations are more likely to:
- Be run by a small group of people or even family members, which can lead to a lack of separation between private and business activities.
- Be inadequately funded on their own which can lead to the owner comingling personal and business assets to keep the business afloat.
- Lack the resources and business knowledge to maintain proper corporate records and maintain strict compliance with their corporation or LLC requirements.
Any or all of these factors may be enough for a judge to order the veil pierced, which is why it is so important for small business owners to obtain adequate legal representation and to have their policies and procedures evaluated annually for compliance with their business’s organization.
If any of the above situations apply to your business and you are worried that you could be held liable, consult a qualified business attorney at Schlueter, Mahoney & Ross, P.C. Our construction attorneys can be reached by phone at (303) 292-4525, at our office, or by filling out the contact form on our Contact Us page.
Our construction law attorneys, Michael A. Schlueter and Elliot Fladen represent clients throughout Colorado, including Denver, Aurora, Broomfield, Boulder, Greely, Commerce City, Lakewood, Highlands Ranch, Littleton, Arvada, Westminster, Pueblo, Thornton, Colorado Springs, and Fort Collins.
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