Forming a legal entity such as a limited liability company or a corporation is a simple first step in limiting some of the risks inherent in running your business. We have written about the corporate shield and its limits. The corporate shield only provides any protection so long as you maintain the shield. If you fail to do so, your business creditors may be able to “pierce the corporate veil.”
The Minnesota Supreme Court established a two part test to determine whether a company’s corporate shield should be disregarded and liability should attach to the individual owners in a case called Victoria Elevator Co. v. Meriden Grain Co. The two elements are (1) whether the corporation is being treated as a truly separate entity, and (2) whether piercing the veil would prevent injustice or fundamental unfairness. The Court went on to enumerate eight factors to consider in determining whether the corporation has been treated as a separate entity, which I won’t go into detail discussing.
As a business owner, it is critical to understand that following corporate formalities can prevent such an inquiry in the first place. This means you should maintain your internal corporate records, including operating agreements, shareholder agreements, bylaws, meeting minutes, etc. It also means your business should function as its books and records describe. In other words, if your bylaws call for quarterly meetings, you should have quarterly meetings and maintain minutes of each meeting. You should have written records of any business decision requiring a vote, including those in attendance and the vote of each attendee.
Most importantly, you must treat your company as a thing separate from yourself. This means your company needs a tax identification number, its own bank account, credit cards, and tax returns. Any transaction you have between yourself and your company must be well documented and for a legitimate purpose. This means you cannot use your company’s money to buy yourself a vacation to Hawaii. It also means you should not use the company car to take a road trip to visit your family in Florida.
This discussion is not intended to be a complete list of prohibited conduct, but merely an illustration of some acts that may jeopardize your corporate shield. If you follow all corporate formalities, keep your internal books and corporate documents up to date, and use company assets for the purpose for which the company exists, you stand a good chance of maintaining your individual protection.