Most companies choose to form a legal entity – whether a limited liability company, corporation, or otherwise – for the avoidance of personal liability to the shareholders or members. In other words, the personal assets of the company’s owner – including homes, cars, savings, and possessions – are not at risk for actions taken by the company when the company is a limited liability legal entity. This limited liability is often referred to as the “corporate veil” because the owners of the company are protected behind it. It is very important, however, for business owners to understand that there are some situations where the corporate veil can be pierced to reach the personal assets of the business owners.
The Corporate Veil in Ohio
In Ohio, the corporate veil will be pierced only if ALL of the following three things are true: (1) control over the corporation by those to be held liable was so complete that the corporation has no separate mind, will, or existence of its own; (2) control over the corporation by those to be held liable was exercised in such a manner as to commit fraud or an illegal act (or another similarly unlawful act) against the person seeking to disregard the corporate entity; and (3) injury or unjust loss resulted to the plaintiff from such control and wrong.
The First Prong: Ohio courts consider the following factors to determine whether a small business exercised dominance and control in the way required to meet the first prong of the corporate veil-piercing test: (1) grossly inadequate capitalization, (2) failure to observe corporate formalities, (3) insolvency of the debtor corporation at the time the debt is incurred, (4) shareholders holding themselves out as personally liable for certain corporate obligations, (5) absence of corporate records, and (6) the fact that the corporation was a mere facade for the operations of the dominant shareholder(s).
The Second Prong: To meet the second prong of the corporate veil-piercing test, there must be either actual fraud or some other unlawful act committed by the owners. A “straightforward tort,” such as negligence is not the type of act that warrants veil piercing in Ohio. Similarly, a breach of contract is not sufficient to meet the second element meet the second prong of the corporate veil-piercing test.
The Third Prong: The third prong is met if there was an economic loss that was caused by the control of the owners and the unlawful act.
How to Avoid Piercing the Corporate Veil
Taking the veil-piercing test into consideration, here are some tips for avoiding personal liability arising from your limited liability business: First, don’t commit fraud. Second, open up a separate business banking account. Third, obtain a federal tax ID number for your business. Fourth, have an operating agreement drafted for your business. Fifth, either have enough money in your bank account to cover expected liabilities for the business or take out an insurance policy to cover expected liabilities for the business. Sixth, keep formal meeting minutes for your company. Even if you are a sole member limited liability company, it is still a good idea to have a “meeting” at least once per year. Crumpton Law LLC can serve as the meeting secretary and assist in keeping your corporate records. And finally, try to avoid personally guaranteeing obligations of the business.
Crumpton Law LLC is a Columbus Small Business Law Firm, with attorney Matthew Crumpton serving as managing member and lead counsel.
Tags: corporate veil, corporation, LLC, small business
