How to Establish a Corporate Veil
How to establish a corporate veil is an essential issue if you own a business, by yourself or with others. If you own your business as a sole proprietor or partnership, you could be held personally liable for your company’s actions. If it is done correctly and the entity owning your business is a corporation or limited liability company (LLC), you may avoid this issue by protecting yourself with a corporate veil.
Lusk Law, LLC, can help your business choose the right way to structure its ownership. There are costs and benefits to every legal entity, so we’ll advise you which one we think would best meet your needs. We also can defend your business in litigation or protect its interests by pursuing legal action on your behalf. Learn more about how a business attorney can help you by calling us at (443) 535-9715.
What is a Corporate Veil?
While you may be familiar with the term, you may not know exactly what a corporate veil is. A corporate veil is where you and the entity owning your business are legally separate. If the company is sued in tort (this is when it negligently caused an injury or committed fraud), fails to pay a debt, breaches a contract, or declares bankruptcy, creditors normally can’t try to use your personal assets to pay a judgment or debt. This legal separation of your business and you is the “corporate veil.”
How to Set Up a Corporate Veil
Creating and maintaining a corporate veil is critical to protecting those involved. It’s bad enough when a company suffers a financial or legal setback. If it takes away the assets of those running it, that could mean the end of the business and personal bankruptcy.
Some Business Entities Offer More Protections for Owners Than Others
Different legal entities can own a business. Some protect owners’ assets, while others do not.
- Sole proprietorship
This is the simplest type of business, and it gives you complete control. It also offers you no protection for your personal assets. You and the business are legally the same. You may find it harder to raise money or get bank loans, but this may be a better choice for a low-risk business. Many businesses start this way, and as they become more successful, a legal entity is created to own the business and help shield the owner.
Partnerships involve two or more owners. Like sole proprietors, they are the only owners. Partners are completely exposed to potential personal liability. They can also be held liable for the other partner’s actions.
There are also limited partnerships (LP) and limited liability partnerships (LLP). LPs have a general partner who runs the business and has an unlimited potential liability, while others enjoy limited liability but limited control. LLPs feature limited liability to every owner. Partners need not pay the LLP’s debts, and they won’t be responsible for the actions of other partners.
- Limited liability company (LLC)
An LLC is a combination of corporate and partnership business structures. An LLC usually protects you from personal liability. Your assets shouldn’t be at risk if the business goes bankrupt or is sued. But if there’s fraud and/or fundamental unfairness in a case, the corporate veil can fail. LLCs may be a good option if your business is medium- or higher-risk for possible liability, you have significant assets to protect, and you prefer a lower tax rate than a corporation.
There are different varieties, but they’re all legal entities separate from those who own them through stocks or shares. If a stock owner leaves or sells their shares, the corporation may continue operating undisturbed. With a corporation, there’s a corporate veil that may protect shareholders. Compared to other entities, corporations have the strongest protection from personal liability for their owners.
There are higher costs and more complexity in corporations than in other business structures. There are record-keeping, operational process, and reporting requirements. Corporate profits may be taxed twice — when the business turns a profit and when dividends are paid to shareholders who pay income taxes.
How Does a Corporate Veil Fail?
A judge’s sense of justice can end a corporate veil’s protections.
Under limited circumstances, a court could “pierce” or “lift” the corporate veil. This will expose LLC members and corporate shareholders, officers, and directors to personal liability. Plaintiffs or creditors may try this if the company doesn’t have enough assets or insurance coverage to pay the claim or debt. In most cases, piercing the corporate veil is complex and may not be worth the effort to try.
Lifting the corporate veil involves equity claims. These are arguments by both sides that fairness demands that their side should win the case. A judge will “balance the equities” and, given all the evidence, decide what’s right under the circumstances.
How to Maintain a Corporate Veil
The existence of an LLC or corporation doesn’t create a legal bubble around you and your company.
Just creating a corporation or LLC isn’t enough to establish a corporate veil. Maintaining a corporate veil goes beyond executing documents and properly filing them. In addition to creating this separate entity, you need to treat it like one, or you risk looking like a fraud.
If a plaintiff can show that certain factors exist, the veil may be pierced, but courts normally require strong evidence to do so. Those factors include:
- Inadequate corporate capitalization
The entity should have enough money and assets to meet its obligations. If not, a judge may see the corporation as just a shell, not a legitimate business entity, because it can do little or nothing by itself.
- Abuse of or failure to maintain corporate formalities
This factor comes into play when the separation of a parent and subsidiary corporation and a corporation and shareholders are disputed. In these situations, the court will want to know if assets are mixed, whether stocks have been issued, if corporate records are kept separate, and whether there have been director or shareholder meetings.
Shareholders control the corporation. But if one shareholder owns nearly all the stock and completely dominates the others concerning finances, policies, or practices, the corporation and stock owner may legally be the same.
If a corporation or its owner does something wrong or says something untrue and it harms others, if the other factors lean toward lifting the corporate veil, it may be enough to convince a judge to decide for a plaintiff. This can include:
- The majority shareholder made unkept promises or guarantees.
- An outside party was led to believe they’re working with an individual or a corporation when that’s not the case.
How Is a Corporate Veil Pierced or Lifted?
Maryland courts will pierce the corporate veil to prevent fraud or to enforce a “paramount equity.” They will need to see evidence of fraud and an important unfairness serious enough to end the traditional protection of a corporate veil.
Another court stated that to lift the corporate veil, the defendant must be guilty of a mistake, an unfair or fraudulent act, or a failure to act. It’s appropriate when a statute must be enforced and a corporate entity is a front for illegal activity. A court may also pierce a corporate veil if the purpose of the business entity is to prevent living up to a binding obligation or when stockholders use corporate property as their own.
Lusk Law, LLC: Advocates for Life’s Obstacles and Opportunities
The experienced business attorneys at Lusk Law, LLC, have counseled CEOs and business partners for many years, finding innovative legal solutions to all kinds of business challenges. If you’re facing a corporate veil issue, our attorneys can advise you on your legal options and counsel you about potential strategies.
To find out more about how we can help, call us today at 443-535-9715.
We’re Advocates For Life’s Obstacles and Opportunities
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