Protecting Your Corporate Shield
Short Answer:
Unless you take steps to maintain corporate/company formalities and keep your business adequately capitalized, your personal assets may be vulnerable.
One of the most useful aspects of forming a corporation, an LLC or an LLP is the protection of your personal assets. Generally, if the business you own is one of these entities, you are not personally liable for the debts and liabilities of the company. There is an exception to this rule. The exception is referred to as the piercing of the corporate veil/shield. Essentially, if your company is run for the personal benefit of its owners and the company is a "mere instrumentality" of the owners, rendering it "unjust" to keep them separate, a court may disregard the corporate shield.
All too frequently, new business owners—by virtue of the nature of being a new business—ignore this exception, when in all reality they may be more likely to have the exception applied to them!
There are approximately 17 factors under California law that can lead to the piercing of the corporate shield (which is similar across other states). The 3 most important questions that a court will ask are:
Was the company and its owners acting as a single economic unit? Did they adequately capitalize the company (putting money into the company and keeping money in the company rather than taking it out for personal use)? Is the company solvent? Were corporate formalities observed (See Section IX)? Did the owners/shareholders/members siphon company funds for their personal use?
Did the company really act as a facade for the dominant owner/shareholder/member? Did he/she pay personal expenses out of business accounts or pay business expenses out of personal accounts?
Would it be unjust or unfair to keep the corporate shield intact?
Generally, the most important factor that comes up time and time again in case law is whether the company was adequately capitalized. If the owners/shareholders/members took the entirety of company money out of the account each month or paid themselves a salary equal to the total profit of the company, the company won't be able to cover any liabilities that arise, in which case a court will likely pierce the corporate veil.
One key factor to note is that the observance of corporate formalities is also important. Thus, even though you aren't required to have a written operating agreement in place if you're an LLC, having one in place greatly strengthens your corporate shield. Similarly, keeping up with your annual shareholders meetings and board resolutions is important if you’re a corporation.
The strength of your corporate shield is a complicated and nuanced legal issue. It is also one that is critical to the protection of your personal assets. As such, it’s recommended that you seek counsel if you have any concerns whatsoever about whether you’re taking adequate steps to ensure the viability of your corporate shield.
