There is a concept known as “piercing the corporate veil,” which can do a lot of damage to business owners that do not take the proper actions in conducting their business to protect themselves. If a creditor is able to pierce the corporate veil, that creditor can go after the personal assets of the business owner(s) to satisfy the obligations of the corporation (or Limited Liability Company (LLC)). Scary stuff.
What is one of the main reasons businesses form corporations or LLCs? Certainly, there is a cost involved, and with respect to corporations, many statutory procedures that must be followed. However, business owners want to shield their personal assets from any liabilities of the business, so they make the decision to operate as a business entity. Business entities are artificial persons. The original purpose of permitting the creation of entities that shield personal assets from liability was to encourage entrepreneurship and entry into the market place, without fear of subjecting one’s personal assets to the liabilities of the business.
The problem is that many business owners form a corporation or an LLC, and then breathe a sigh of relief that no creditor can touch their personal assets, and believe they are completely protected since they have elected to conduct business as a corporation or an LLC. The sobering truth is that this is not always the case if the business owner has not been properly educated as to how to properly conduct business through the chosen business entity.
The courts in Pennsylvania do not take piercing the corporate veil lightly, and will do so only if certain facts exist. There is currently no Pennsylvania statute that addresses piercing the corporate veil, but for years the Pennsylvania courts have addressed the circumstances under which a creditor may succeed in piercing the corporate veil. In Lumax Industries, Inc. v. Aultman, 669 A.2d 893, 895 (Pa. 1995), the Pennsylvania Supreme Court stated that “there is a strong presumption in Pennsylvania against piercing the corporate veil.”
The Pennsylvania Supreme Court cited the Pennsylvania Commonwealth Court in setting forth the factors to be considered in determining whether to pierce the corporate veil. The four factors cited were: (1) undercapitalization; (2) failure to adhere to corporate formalities; (3) substantial intermingling of corporate and personal affairs; and (4) use of the corporate form to perpetrate a fraud.
Although the Pennsylvania courts have not directly addressed whether the concept of piercing the corporate veil applies to LLCs in the same manner as it does to corporations, the safe practice would be to assume that the Pennsylvania courts would permit piercing the corporate veil of an LLC. Therefore, the conduct of business through an LLC should be done in a manner that would avoid having a creditor successfully argue that it should be permitted to pierce the corporate veil of the LLC.
In deciding whether the corporate veil of an LLC could be pierced in Walmsley v. Ehmann, No. 1845 EDA 2009, slip op. at 14, 16-17 (Pa. Super. Ct. Feb. 28, 2012), the Pennsylvania Superior Court stated that an LLC need not adhere to the same formalities as a corporation, and the lack of formalities must lead “to some serious misuse of the corporate form.” The Superior Court went on to say that undercapitalization of an LLC is only relevant for purposes of piercing the corporate veil if it leads to an inference that the LLC was formed in order to defraud its creditors or for some other improper purpose. While the statements made by the Pennsylvania Superior Court in the Walmsley case are dicta, they are also indicative of the opinion of the Pennsylvania Superior Court as to whether there are circumstances under which the corporate veil of an LLC can in fact be pierced, as can occur to a business operating under the corporation structure.
It was clear from the Walmsley case that failure to adhere to corporate formalities in the same manner as is required for corporations would not lead to any negative presumptions to pierce the corporate veil, however, LLCs, as well as corporations, should conduct their business in a manner which clearly treats the business entity as a separate legal “person” in order to avoid having the business owners on the hook for the personal liabilities of the business.
In the case of corporate entities, regular meetings should be held and minutes of the meetings should be taken and kept in the corporate minute book. Meetings of both the Board of Directors and shareholders should be held and documented. This type of formality is not required of an LLC, though having some type of documentation that an action was approved in accordance with the Operating Agreement would be beneficial. If you do not have an Operating Agreement and your business was established as an LLC, it would be prudent to speak to your business lawyer about preparing an Operating Agreement for the LLC. The legal entity and the owners should not co-mingle funds. Establish a separate bank account for the legal entity.