Business Asset Protection

Does It Really Work?

When you are starting a business, you may read about setting up a business entity through which you will conduct your business. One of the big reasons for doing so, you read, is to protect your personal assets from exposure to potential liabilities and claims involving the business.

Many folks starting out will set up a corporation or a limited liability company (LLC) to house the business.

In that context, there are two main areas of concern for protecting assets – the assets of the owner or owners of the business entity and the assets held within the entity itself.

In this post, we’ll consider the first area – protecting the assets of the business owner(s)

Protecting Owners’ Personal Assets – aka ‘Piercing the Veil’

What Is It?
You’ve probably heard about the concept known as “piercing the (corporate) veil.” But what exactly is ‘piercing the veil’ and how does it work?

The basic “black letter law” is that the owner or owners of a corporation or LLC are not liable for the debts of and claims against the entity. This is the liability “veil” or “shield” of the entity. ‘Piercing the corporate (or LLC) veil’ is a legal principle sometimes used by courts to ignore that liability shield. What happens is that a creditor or claimant alleges the entity is being used for fraud or some other wrongful action affecting the creditor. If the court agrees, it might permit the creditor to satisfy its judgment against the assets of the owners of the corporation or LLC.

When Would a Court Permit It?
Courts look at various factors to decide whether the “veil” should be pierced. The key factors include:

• Is the entity under-capitalized for the type of business conducted?
• Has the owner mixed up the finances of the business with the owner’s personal finances?
• Does the documentation for the business entity look adequate?

The common theme that runs through all of the factors is this: Is the LLC or corporation truly a separate entity from its owner(s) – or is the distinction blurred?

Sadly, many if not most owners do not take proper care to maintain the distinction.

The Shaky Status of the Single Owner LLC (or Corporation)
Now here is another key point: if the corporation or LLC has only one member or shareholder, it may be easier to see whether the entity’s documents and activity have been kept separate from that of the owner. And in many cases, the answer will be ‘no’. That leaves the single-owner entity more vulnerable to a piercing-the-veil attack.

[In the next post, we will look at what, if anything, can be done to “plug the holes” in single member LLC shield. We’ll also consider the ins and outs of protecting the assets of the business, as opposed to those of the owner.]