(Reverse) Piercing the Corporate Veil—Why Business Formalities are Necessary
A owner–debtor who has insulated their assets within business entities, corporate structures, and trusts is on the path to asset protection. What must the debtor do to maintain the plan? The entities themselves provide protection, but only if used properly.
In order for the liability shield of the company to be effective for the debtor, the debtor and the company must be separate entities and must maintain their legally-distinct nature.
If the business entity is mis-used by the owners, the owners will become personally liable. Factors of mis-use include:
- Absence or inaccuracy of corporate records;
- Concealment or misrepresentation of members;
- Failure to maintain arm's length relationships with related entities;
- Failure to observe corporate formalities in terms of behavior and documentation;
- Failure to pay dividends;
- Intermingling of assets of the corporation and of the shareholder;
- Manipulation of assets or liabilities to concentrate the assets or liabilities;
- Non-functioning corporate officers and/or directors;
- Significant undercapitalization of the business entity (capitalization requirements vary based on industry, location, and specific company circumstances);
- Siphoning of corporate funds by the dominant shareholder(s);
- Treatment by an individual of the assets of corporation as his/her own; or
- "Alter ego theory:" Was the corporation being used as a "façade" for dominant shareholder(s) personal dealings?
Because of these factors, maintaining corporate formalities are important, including meetings and minutes of the meetings.
Additionally, reverse piercing of the corporate veil is recognized. Namely, where owner domination of the corporation exists, cases have held that the corporation may be held liable for the owner's debt.