There are a number of reasons to form an LLC, S-Corp, or other corporate form, but one of the biggest reasons is right there in the first two initials of an LLC: Limited Liability. By creating an LLC or similar corporate formation for your business, you can prevent creditors from holding you personally liable on your company’s debts. This works out nicely, except when it doesn’t. Occasionally, courts will allow plaintiffs to “pierce the corporate veil” in order to recover personally from the owners of the company, which means you could lose everything.
Whether a court will allow a plaintiff to pierce the corporate veil is based on state law, but most states follow similar principles. As New York courts have ruled, if plaintiffs can show that the owners of a company abused the corporate form by using it for their own personal benefit and not the company’s, then piercing may be allowed. Here’s how not to let that happen.
Keep Records of Your Corporate Formalities!
Make sure that you are actually adhering to the formalities that accompany your state’s business requirements for your chosen business entity (e.g. an LLC) and keep proper records of doing so. If you start an LLC and create foundational documents which include bylaws and rules regarding annual meetings, make sure that you are actually following your bylaws (i.e. holding annual meetings) and that there are diligently-kept records of all business matters and meetings, such as paystubs and meeting minutes. If your founding documents say you will have an annual meeting, then make sure you have the meeting and keep a record of it.
A lack of these records will suggest to the court that you are simply doing business for yourself with the business just as a sham cover. Furthermore, have all documents be on company letterhead, not your personal letterhead, and make sure you and others are signing documents and agreements on behalf of the company, not your individual selves.
Don’t Commingle Company and Personal Funds
If there is one thing courts hate seeing, it’s an owner using company funds for his own personal use and/or failing to keep company and personal accounts and expenses separate. If you are using your LLC’s bank account as your personal piggy bank, or if the LLC is freely drawing on your personal bank accounts to pay company expenses (or you are depositing company funds in your own accounts without making the proper distribution through the LLC form), then the court may be much more willing to pierce the corporate veil and treat both your accounts and the LLC’s accounts as one-in-the-same for paying off debtors and plaintiffs.
Simply put, create separate banking accounts for your company and your personal accounts, and never mix the two.
Make Sure the Company is Properly Funded
Another red flag that courts will pick up on is inadequate capitalization. If your company has $100,000 in debts, but you are constantly making distributions of revenue from the LLC to the owners, leaving the LLC with $5,000 in cash on hand, that might be a sign to the courts that you are not concerned with the ongoing survival of the company and are instead trying to improperly divert funds out of the reach of creditors.
Legal Guidance to Protect Your Growing Business
At The Gouchev Law Firm in New York, we work with businesses of all sizes, including start-ups and franchise businesses, across New York City and New Jersey, in meeting all types of transactional needs. Call us at (212) 537-9209 or schedule a free strategy session today to see what The Gouchev Law Firm can do for your business.