Protecting your Personal Assets: The Importance of Proper Entity Formation
A principle benefit of choosing a corporation or limited liability company (LLC) as your choice of business entity is the protection from personal liability provided to each owner. Individuals with an ownership interest in a corporation or LLC are protected from personal liability for business decisions or actions of the business entity. This means that if the company incurs debt or is sued, as a general rule, an individual owner’s personal assets are usually exempt. Undoubtedly, this is a major benefit to the owner, but don’t be fooled, the liability protection of a corporation or LLC is not guaranteed by simply filing the proper documents with the state. Minnesota requires corporations and LLCs to adhere to specific laws, and when those laws are not followed, the individual owners of the entity may see themselves on the hook for debts or lawsuits against the company.
I. Separate and Distinct
At the outset, it is recognized that a corporation or LLC is an entity, separate and distinct from its owners, and that the debts of the company are not the individual indebtedness of its owners. This principle is equally applicable, whether the corporation has many or only one owner. In appropriate cases, however, the court may choose to disregard the corporate entity and the company and its owners will be treated as identical, thus leaving the personal assets of its owner exposed. When this happens, it is called piercing the corporate veil.
II. Piercing the Corporate Veil
In Minnesota, courts can choose to pierce the corporate veil, holding an individual owner liable, when that owner uses the business as an extension of themselves. To make this determination, courts look to the reality and not form, with how the business operated and the individual owner’s relationship to that operation. Courts will pierce the corporate veil when they find an individual shareholder used the company as a mere “instrument” or “alter ego” of themselves, i.e. not a separate entity.
III. Factors Courts Consider When Piercing the Corporate Veil
Courts balance several factors when considering whether a business is a mere “instrument” or “alter ego” of an owner. The factors include:
- Whether the corporation failed to observe corporate formalities;
- The absence of corporate records;
- Existence of the corporation as merely a facade for individual dealings;
- Commingling of corporate funds; and
- Non-functioning of corporate offices and directors.
Where the above factors are present, courts find that to allow an individual to escape liability because they do their business under a certain business form is to allow them an advantage they do not deserve. Closely held corporations and LLCs, those with few or a single shareholder, are inherently more susceptible to having the corporate veil pierced. Business formalities can often seem unnecessary and even burdensome given the structure and close relationship each owner has with the company. To that end, it is important for those owners to be aware of the risks associated with neglecting business formalities.
IV. Avoiding Personal Liability
A principle step in preventing the piercing of the corporate veil is taking the time to follow required business formalities. In addition to filing the business with the state, it is maintain other business records including bylaws, minutes of ownership meetings, appointed directors and officers, property transfers, and certificates of stock or membership. Many of these steps may seem unnecessary to the sole owner of a corporation or LLC, but they serve the purpose of showing that the business is treated as its own unique entity. In the event the business was sued and an attempt to pierce the corporate veil was made, those formalities help protect each owner from personal liability.
V. Taking the Next Step
We encourage any business owner who wishes to learn more about protecting themselves and their business to contact our business litigation attorneys. Each business is unique, having its own goals and direction, and we will work with you to learn about your company, and to craft company documents to meet those unique needs and your ownership structure. This will not only provide you a blueprint on how to handle problems as they arise, but also give you that foundation to prevent veil piercing. You care about your business and so do we. Take the time to protect it and yourself. Call Tentinger Law Firm at 952-953-3330 to learn how we can help.