In this final part of my New Business Start Up Series, we will discuss the pitfalls of being a single member LLC or corporation. (Hint: there is one huge pitfall and it’s called piercing the corporate veil.)
As you may remember from part 2, one of the primary benefits of having a corporation or limited liability company is that the owners have personal liability protection – meaning that if a creditor obtains a judgment against the LLC or corporation, they cannot reach the assets of the individual(s) who own the LLC or corporation.
In some cases, the courts have determined that it would be unfair to allow the owner of a business to hide behind the corporate liability shield for some acts. That’s where piercing the corporate veil comes into play (also known as “disregarding the corporate entity.”)
So, what are the core elements that a plaintiff would have to establish to pierce the corporate veil of a business? There is a three part test that has been laid out by the Ohio Supreme Court, which echoes the veil piercing tests of other states.
The Ohio Supreme Court laid out the test for piercing the corporate veil In Belvedere Condominium Unit Owners' Assn. v. R.E. Roark Cos., Inc. (1993), 67 Ohio St.3d 274. The Court held that "the corporate form may be disregarded and individual shareholders held liable for wrongs committed by the corporation when:
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;
control over the corporation by those to be held liable was exercised in such a manner as to commit fraud, [an illegal act, or a similarly unlawful act] against the person seeking to disregard the corporate entity; and
injury or unjust loss resulted to the plaintiff from such control and wrong.
Let’s to step-by-step to break down the risk and the strategy for how to avoid having your corporate veil pierced.
Regarding the first element of complete control over the corporation, as a practical matter, most single owner companies are in complete control. But, lucky for you, the courts have laid out measures that owners can take to not be seen as being in complete control (even though they are). First, make personal purchases out of the corporate account. Second, make sure that your company maintains corporate formalities by having regular meetings and a signed operating agreement or bylaws/regulations.
For the second element, the plaintiff must prove that the business (through the defendant individual’s actions) committed fraud or a similarly unlawful act) against the person seeking to disregard the entity. The headline here is do not commit fraud or other illegal acts against a person. Without fraud or an illegal act, courts will rarely, if ever, pierce the corporate veil, even if there are issues with disregarding the corporate entity.
Finally, the last element is that the plaintiff must have some actual damages which were caused by the defendant’s fraud or similarly illegal act. This last element could allow a defendant to argue that their bad act did not cause the harm that is alleged. Nevertheless, it’s best to just avoid fraudulent and illegal acts in the first place so that this does not become an issue.
In summary, so long as you maintain your corporate formalities (meeting minutes, not spending from the wrong accounts) and do not commit fraud or illegal acts, you can avoid losing your limited liability protection with your single owned corporation or limited liability company.