Undercapitalization & Piercing the Corporate Veil
A while ago, I posted a video about piercing the corporate veil and how it can be used to get to the assets of a business owner for the liability and the debts of the business. One of the factors that goes into piercing the corporate veil is undercapitalization, which basically means that your business doesn’t have enough money for it to run and to pay its debts and liabilities. If your business is undercapitalized, that is one factor that could lead towards a judge or a court deciding to pierce the corporate veil and hold you personally liable for your business’s debt.
Someone asked me recently to expand on this concept of undercapitalization and to go into a bit more detail on how exactly it leads to piercing the corporate veil. So, here goes!
The reason undercapitalization can expose you to piercing the corporate veil is because if you don’t have enough money in your business to pay for your debts or reasonably expected liabilities, or to pay for your overhead, it can look like you are purposefully keeping money out of your business in an effort to avoid any liability. It’s not completely unreasonable to have this thought that if I don’t have any money or any assets in my business, and somebody sues the business, they are not going to be able to collect anything, so I might as well just keep everything out of my business so it has no assets and there is nothing that can be collected if there are any lawsuits, debts, or liabilities against the business.
But doing that, and in particular intentionally doing that, will make it look like you are doing it purposefully to defraud or avoid creditors or liabilities. And judges don’t like that! And that is an instance where they are going to pierce the corporate veil and hold you personally liable because your business doesn’t have any assets.
Making sure that your business has adequate capitalization and has enough money to operate and pay its debts and liabilities makes it look like you are a legitimate business. And because you are a legitimate business, a court or a judge should uphold that corporate liability protection that you get from an LLC or a corporation.
So really, that’s it. It’s not too complicated. Basically, undercapitalization of your company makes it look like you may be doing it to intentionally to avoid having to pay for your business’s liabilities.