The number one reason to incorporate is to protect yourself from business debt. The good news for entrepreneurs is that incorporating to avoid personal liability is completely legitimate.
But that protection can be lost through a process known as “piercing the corporate veil” if the corporation is not treated as a “real” corporation. If that happens, a court can lift the corporate veil, thereby allowing a creditor to recover from principals debts owed personally on behalf of the corporation, if the creditor demonstrates, among other things, a “sufficient unit of interest and property that The separate personalities of the individual and the corporation no longer exist.” Essentially, this means that business owners become personally liable for business debts even though they were incorporated.
It all comes down to what happens after onboarding. Entrepreneurs run into trouble when they exert “complete domination and control over the corporation.” Finding out if the business owner had this kind of control over the corporation rests on the facts of the particular case, but over the years, courts in California and New York have told us exactly what they are looking for:
-Mix funds and other assets
-When the business owner treats corporate assets as his own (for example, paying off personal credit cards with corporate funds)
-Do not issue shares.
– The affirmation by an individual that he is personally responsible for the debts of the company;
-Do not keep corporate minutes.
-Inadequate capitalization
For a full list of the kinds of things courts look at, see Piercing the Corporate Veil: A Rare and Drastic Outcome.
While the piercing of the corporate veil is a rare outcome, the consequences can be far-reaching. There have been cases where the owners of a business were personally liable for $4.5 million after the court found that the business owners paid personal expenses with corporate funds; the corporation was undercapitalized; and financial records and corporate minutes were not properly maintained (even for the most significant events in the companies’ history). Other times a businessman has been found personally liable for $4.3 million when the business owner used the corporation’s assets to pay off his personal debts, including credit card and car loans, and the money moved freely between bank accounts. personal and those of the corporation.
The danger arises when the business is not treated as belonging to the corporation rather than its individual owners. That is why the court will analyze whether corporate and personal bank accounts were maintained; whether corporate funds were used to pay shareholder debts; if the corporation had its own business address? Have stock certificates been prepared and issued? Were shareholders’ and directors’ meetings held regularly, especially to approve key business decisions? Were the minutes of all those meetings properly kept?
The lesson is clear: the corporation and its individual owners must be treated separately to maintain the protection of the owners’ personal assets that the incorporation process normally provides.