|
Memoranda
T
o: Clients that Own Small Business
From: The
Fernandes Law Firm
Re: Practices
to Avoid Personal Liability
Date: December
06
Introduction
If you have or are going to start an operational Company, The
Fernandes Law Firm wanted to provide you with some general
information on the steps you should take as a Shareholder/Member
to prevent an effort in some future court proceeding to pierce your
Company’s “corporate veil” and hold you personally
responsible for the debts and obligations of the Company. This
Client Memo is not, nor is it meant to be, a definitive treatise on
the theories and application of what is known as the “piercing
the corporate veil” doctrine, rather, its purpose is simply to
provide you with some straightforward suggestions that you should
incorporate into the day-to-day operations of your Company (whether a
corporation or an LLC) which, if consistently followed, will reduce
the likelihood that a court will break your Company’s liability
shield to hold you personally responsible for the financial
obligations of the business.
Analysis
One of the principal legal benefits for business owners using limited
liability companies or corporations is to conduct their commercial
operations under the liability shield conferred on the
Members/Shareholders by the operative Wisconsin Statutes (Chapter 180
for corporations & 183 for LLC’s). This liability shield
typically protects the Members/Shareholder’s personal
assets—e.g., their homes and savings—from being
“at risk” to satisfy the debts and obligations of the
Company. In other words, the Member/Shareholder may loose their
investment, but beyond that, they are not liable for the business’s
debts—assuming that the entity has been properly organized,
financed and no personal guaranties are enforceable.
In certain circumstances, however, courts can “pierce the veil”
of a corporation or an LLC—that is to say, the court disregards
this personal liability protection and holds the Members/Shareholder
(and/or managers if any) individually accountable for the
claims, debts and obligations of the Company. Therefore, it is
worthwhile for Members/Shareholders to take reasonable measures that
serve to undermine such efforts to pierce the Company’s
liability shield. Some basic procedures and preventative steps
individuals can (and should) regularly employ are summarized herein.
1. LLC Members/Shareholder Should Not Use The LLC To Commit Fraud
Or Other Misconduct.
This statement seems obvious; however, courts are very reluctant to
pierce an LLC’s veil unless the Members/Shareholder used it to
commit a fraud or other serious wrongdoing and then try to use the
Company’s liability shield to avoid any personal responsibility
for their own egregious conduct. Judicial authorities are quick to
disregard the corporate form when fraud is present. In fact, fraud
and fraud-like conduct is consistently the number one reason used by
courts to pierce the company’s corporate veil. The simplest
and most effective way to avoid personal exposure from a court
piercing your Company’s liability shield (and, obviously, for
many other strong legal and ethical reasons) is for
Members/Shareholder to steer clear of any such transgressions.
2. Corporate Shareholders & LLC Members Should expressly
Refer To Their Corporation as a Corporation or the LLC as
An LLC.
In general, whenever Members/Shareholder mention their company to
third-parties (verbally or especially in writing), they should
expressly refer to the Company as an LLC or corporation. This
practice is the most effective means of putting third-parties on
notice that they are dealing with a separate legal business entity,
and not the individual Members/Shareholder. Consequently,
third-parties that are put on this notice can only look to the
Company (and not to the Members/Shareholder) for the satisfaction of
any claims, debts or obligations involving the entity.
A simple illustration exhibiting this practice is for the
Members/Shareholder as a rule to make sure that the initials
“LLC” or “Limited Liability Company” “Inc.”
et cetera., appears after the Company’s name on
stationery, invoices, checks, the business cards of its
Members/Shareholder and employees as well as on any other printed
materials prepared by the Company that could be communicated to
third-parties. Additionally, Members/Shareholders should normally
refer to the Company in discussions with clients, suppliers and
others as “my/the LLC or corporation” rather than merely
“my company” or some other ambiguous term.
3. LLC Members/Shareholders Should Maintain Separate Books And
Accounts For Themselves as Individuals and for the Company.
The underlying rationale for the legislative shield that corporations
and LLC’s afford their Members/Shareholders is the creation of
a “legal fiction” of separation: setting the business
entity apart from its individual Members/Shareholders. To
acknowledge this distinction, Members/Shareholders should take
reasonable steps to illustrate and document this legal divide. By
way of example and not as a limitation:
You should keep separate financial books, records, checking and
deposit accounts, et cetera.; and
You should not withdraw money from the corporate or LLC account for
personal use, nor should you deposit personal money in the Company
account without first making written records of these dealings to
illustrate that they were at “arm’s-length.”
The commingling of your Company’s and its Member’s/Shareholders
accounts (or related companies for that matter) suggests to a court
and third-parties that the Member/Shareholder themselves have
disregarded the separateness of the Company and, not surprisingly,
the court will too. In the same vein, limited liability companies
pose a greater risk to their owners that the entity’s veil will
be pierced because one characteristic of LLC’s is a greater
informality the LLC Members are afforded within this particular
business organization over that provided by a traditional
corporation. Thus, Member’s should pay special attention to
the LLC’s operations so as not to let this flexibility and
informality of doing business (as an LLC) give a court or others an
opening to question the propriety of the Company’s affairs.
4. LLC Members/Shareholders Should make sure that at the Time of
organization and thereafter, that the Company is Adequately
Capitalized.
Courts can question the propriety of operating an company and pierce
the veil if the entity lacks adequate capitalization—that is,
if its aggregate equity contributions, business assets, cash flow,
insurance, and other financial resources are plainly inadequate to
pay its debts when due or where there is an obvious lack of resources
to conduct the business activities of the business as planned. In
other words does the Company have enough resources to pay ongoing
regular business obligations? This does not mean, however, that the
company checking or other deposits must have substantial funds
invested at all times. In fact, an on-going line of credit from a
bank or other institution will be helpful in establishing that the
Company was sufficiently capitalized.
Members/Shareholders should take appropriate steps to make sure that
their company is adequately capitalized in proportion to your
business undertakings.
5. When acting on behalf of the corporation or LLC,
Members/Shareholder should avoid taking or failing to take actions
that may imply to third-parties that they are acting on their own
behalf instead of the company.
When acting on behalf of the Company, you should avoid taking any
action that may be seen by others as you acting on your personal own
account instead of the LLC/corporation. When appropriate,
Members/Shareholders should overtly state that they are representing
their Company. The most common example is for Members/Shareholders
to clearly execute all business contracts and correspondence as an
LLC Member or officer of the Corporation, similar to the
following:
_______________, LLC
By: __________________
Title: Member
Again, this
practice efficiently puts those parties dealing with your Company on
notice that they are indeed contracting with the Company and not one
of its Members/Shareholders personally.
6. Members/Shareholders Should require that the Corporation/LLC
follow any pertinent formalities imposed under WISCONSIN Law as well
as any procedures agreed to under a member, operating or SHAREHOLDER
agreement.
Unlike traditional business corporation laws, LLC legislation imposes
far fewer statutory formalities in the operation of the LLC. In
contrast to most corporate statutes, for instance, LLC laws generally
do not require the Company to hold an “annual meeting” of
its Members or direct LLC’s to issue certificates of interest
to its owners. However, to the extent that the Wisconsin Limited
Liability Company Act does entail the following of certain
formalities, you should take the time to properly observe them and
document your compliance. For example, Wisconsin Statute §
183.0405 states that an LLC shall maintain specific records (e.g.,
tax returns, copies of the articles of organization and operating
agreements) at the Company’s principal office so they are
available for inspection by the other Members. All Members involved
in the operation of the business should make sure the Company follows
these types of formalities as well as any additional “red tape”
that is created by your own “Members” or “Operating
Agreement.”
Not only does the practice of routinely documenting the decisions of
the Member and Company actions help prevent claims by third-parties
to pierce the corporate veil, it also serves to reduce
misunderstandings between the Members/Shareholders.
Conclusion
Often there is a huge temptation to
head to an attorney’s office, have them fill out the necessary
paperwork to form an LLC or corporation and give no further thought
to the matter. If that is the case, then the piercing-the-veil risk
runs higher for such individuals. So what are some of the measures
you can take to minimize any claims to hold you, the
Member/Shareholder, liable?
Execute and follow an operating agreement or shareholder
agreement—the scope of limited liability protection is often
severely diminished unless matters, such as distributions and record
keeping, are dealt with in a written agreement and followed
accordingly;
Give the business a reasonable amount of capital;
Keep all finances of the Company separate from those of its
Members/Shareholders and other entities;
Use the name of the Company as it was filed when the entity was
formed, including the limited liability company or Inc.
designation (“LLC”), on all papers used in the
business—business cards, stationery, invoices, and the like;
If business is not conducted under the filed (or “true”)
name of the Company (i.e., d/b/a _____), file all papers
necessary to conduct business using a trade name;
Open all accounts and execute all purchase orders, leases,
contracts, and other written agreements in the name of the company;
Obtain all governmental licenses in the name of the company;
Obtain an employer identification number (“EIN”)—the
IRS requires it if the LLC has employees and the IRS will also issue
an EIN to a LLC without employees;
Acquire, hold, convey, and otherwise deal with all property of the
business, real and personal, in the name of the company;
Obtain insurance that specifically covers the company; and
In short, “hold yourself out” as a Limited Liability
Company or Corporation in all ways possible in the conduct of
business.
These details and suggestions may feel
like “over-kill” or “form over substance”
now, however, chances are that a scenario will arise down the road
where a court is asked to look at piercing the Company’s
liability shield to hold you personally responsible for the business
debts of the entity; your case will be substantially stronger with a
consistently documented paper trail illustrating that:
You
observed the requisite “corporate” formalities;
Adequately
capitalized the venture; and
You
did not use the Company to commit a fraud.
Under most circumstances, this evidence is very
helpful in defeating actions to “pierce the corporate veil.”
|