A big concern for small business owners is (and if not, it should be) piercing the corporate veil. A main reason for forming a business as a corporation or limited liability company is to protect the personal assets of the business owners. In a corporation or LLC, the owners typically will not be personally liable for the debts or obligations of the company. However, in some situations, a court will determine that the owners are personally liable for the debts of the company. This is “piercing the corporate veil.” When a court pierces the corporate veil, the business owner’s home, bank accounts, and other assets may be tapped to satisfy the debts of the company.
The court determines whether it’s appropriate to pierce the corporate veil via a three-prong test.
The Three-Prong Test Includes:
- First, the court will look at the facts of the case to see if the company is the “alter ego” of the business owner. More on that later.
- Second, the court will consider if the business owners are using the limited liability of the company to defraud the otherwise legitimate claims of creditors. There’s a couple ways the court considers this. If the company borrowed money that the owner knew it probably wouldn’t be able to pay back. Also if they made business deals knowing that the company probably didn’t have enough money to pay for. Those are indicators to the court that piercing the corporate veil may be appropriate.
- Third, if it would be “inequitable,” to let the business owner get away with not paying its creditors. The court will be more inclined to pierce the corporate veil and hold the owner personally liable.