Piercing the corporate veil
Forming a corporation, or limited liability company, helps protect your personal assets from claims against your business.
In other words, your personal bank accounts, real estate, equipment and other personal property, wages and investments are generally guarded from your company’s creditors, or others who have been harmed or injured by your company.
This is because courts will recognize a corporation and LLC as separate from its shareholders and members. However, this protection is not automatic. Courts may disregard limited liability when a company is treated as someone’s alter ego.
Simply stated, a corporation, or LLC, is a shield; wield it correctly and your personal assets are protected. If you set it down, ignore it or become clumsy, your personal assets are no longer protected. As a result, your personal assets are exposed because you are personally liable for the company’s debts, contracts and damages.
On Oct. 24, 2013, the Michigan Court of Appeals made this risk apparent in Woodridge v Williams. Douglas Williams owned a roofing company that was sued for a breach of contract. The company lost the lawsuit and was held liable. Soon thereafter, the company declared bankruptcy. Even though the company could not pay, Williams was forced to pay with his personal assets.
In reaching its decision, the court noted that Williams lost the protection usually afforded by an LLC for several reasons:
- He used the company to pay for his personal expenses including his car, cable, Internet, telephone service for his entire family, and country club and athletic club membership fees.
- He made personal loans to his company without bothering to execute promissory notes.
- He removed money from company bank accounts in order to avoid paying the judgment against the company.
These factors, and more, effectively turned the company into his alter ego. As a result, he was held personally liable.
The court’s decision was a strong reminder to members of LLCs and shareholders of corporations of what they should do to prevent acquiring personal liability. Here are a few general guidelines to follow:
- Make sure all entity-related documents are signed by the entity, not the individual.
- Do not mix or commingle your personal assets with those of the company.
- Keep accurate records and record promissory notes whenever you make a loan to the company.
- Act in good faith and do not shift assets from the company to avoid liability.
- Keep your personal accounting, as well as financial accounts and records, separate from those of your company.