The veil of incorporation limits the personal liability of corporate directors, officers and employees for actions taken by the business. However, business owners can still be liable for business activities if they failed to follow corporate guidelines, commingled assets or acted recklessly.
The Corporate Veil
One of the biggest advantages to forming a corporation is the limited liability for company owners. In a corporation, owners aren't liable for business debts. That means, if your corporation runs out of money, creditors can't come after your personal assets to fulfill business debts. You also can't be personally sued for what other people, like another officer or an employee, do on behalf of the company. This limited personal liability is referred to as the corporate veil.
Piercing the Corporate Veil
The concept of the corporate veil is that, from a legal and accounting perspective, a corporation is actually a separate entity. If there's not a clear distinction between what you're doing as an individual versus what the corporation is doing, a court of law may "pierce" the corporate veil -- in other words, hold you liable for actions taken by the business.
Specifics vary by state, but some of the events that may convince a court to pierce the corporate veil include:
- Mingling business and personal assets: for example, paying for your personal expenses out of the corporate checking account.
- Not capitalizing the corporation: in other words, not investing sufficient funds for the corporation to do business.
- Not following the corporate formalities, such as hosting board of directors meetings, keeping meeting minutes and ensuring company representatives abide by corporate bylaws.
- Acting recklessly or fraudulently: for example, making business deals on behalf of the corporation that you know the business can't pay for.
There are other situations in which limited liability won't protect you. For example:
- If you personally guarantee a loan or debt.
- If you directly injure someone.
- If you fail to pay the payroll taxes withheld from employee wages.
According to Wex, Cornell University's legal encyclopedia, courts are more likely to pierce the corporate veil if the corporation is a close corporation -- meaning, it has fewer than 35 shareholders -- and if it's not publicly traded.
Effects of Piercing the Veil
If the corporate veil is pierced, a court may find you personally liable for business debts or actions taken by the business. With a court order, a creditor can freeze your bank account and debit funds to cover the judgement amount. If you don't have the cash to pay the judgement, the court may allow the creditor to garnish your future wages.
Based in San Diego, Calif., Madison Garcia is a writer specializing in business topics. Garcia received her Master of Science in accountancy from San Diego State University.