You may have heard mention of the corporate veil – the common term for the liability protections afforded to an individual (or entity) who creates a separate company to do business. However, this protection is not ironclad. Read our blog as we discuss the corporate veil, what it is, and why you should care.
For purposes of our discussion, let’s assume Ellen runs a canoe making business out of her garage called Handcrafted Canoes. If she doesn’t create a corporation or limited liability company (or other liability limiting entity), she is personally liable for all of the debts of the business. In other words – her personal assets are subject to claims relating to the business. Ellen’s smart attorney advises her to set up a corporation, and Ellen takes the advice. Handcrafted Canoes, Inc. (HCI) is formed as a Minnesota corporation.
But is that the end of the story? If Ellen’s only act is to set up the corporation, and she doesn’t actually operate her business as a separate entity, creditors of her business may be able to get past that corporate “veil” and proceed against her personal assets.
Parties that do business together have a reasonable expectation that if something goes wrong, the wrongdoer will be held accountable. When the wrongdoer is an entity, the owners aren’t personally liable, only the entity is, and this should be the reasonable expectation of all the parties. But what if the parties don’t KNOW a corporation has been formed? Knowing who/what we are dealing with sets our expectations for options if things go wrong.
If Ellen has a personal canoe collection worth millions, but I know I am contracting only with her corporation, I should understand that I won’t be able to get at her collection if I have a judgment against the corporation. But what if Ellen never tells me she has a corporation, and all the paperwork just has her personal name on it? I might decide to buy a canoe from her because she would seem to have the means to fix errors that are made. An action against Ellen by creditors who didn’t know they were dealing with a corporation is an action to “pierce the corporate veil.”
In Minnesota, courts will generally look at the following factors when deciding whether a shareholder can be held liable for company debts (i.e. deciding that the shareholder didn’t run the corporation like a separate entity):
In practice, it’s fairly easy to make sure the world knows it is dealing with an entity, and not an individual. Here are a few best practices:
The above discussion is equally true for limited liability companies and other liability limiting entities like limited partnerships. Be warned – those doing business with you need to know that they are doing business with an ENTITY and not you, individually.