Clients frequently ask me if incorporating can really protect their personal assets.
This is my second article on this topic where I revisit the original article and now discuss what the courts say about losing corporate protection. Because new clients have been asking about the protection afforded by incorporating, I feel compelled to review a topic incredibly important to all trucking companies
I have always said all trucking businesses should be incorporated:Trucking is a risky business. Disaster looms around every corner and the consequences of negative events can destroy companies and the livelihood of their owners. This rings true for large trucking companies and individual owner operators: anyone involved in trucking and transportation needs to take steps to protect themselves from overwhelming liability. If a company follows proper corporate protocol, the owners, shareholders, and officers should be able avoid personal liability for the company’s debts/liabilities.
However, courts will sometimes hold a corporation’s owners and shareholders personally liable for business debts. This is called “piercing the corporate veil”. Corporations enjoy a “veil” of limited liability, but this can be lifted if a court decides the owner/shareholders are not entitled to corporate protection.
Corporations are legal entities and are separate from the people who own them.The major advantage of forming a corporation is the owners have limited personal liability for company debts. Usually, Corporation owners or shareholders cannot be held personally responsible for business debts. However, courts can ignore the limited liability status of the corporation and hold its officers, directors and shareholders personally liable for its debts. As stated above, this is called “piercing the corporate veil”. Small corporations are at greatest risk for having their veils pierced. “Closely held corporations” – corporations owned by one or just a few people – are most likely to get their veils pierced.
When a corporate veil is pierced, the owners/shareholders can be held personally liable for corporate debts. When this happens, creditors can go after the owner’s home, bank account, investments, and any other assets to satisfy the corporate debt. Therefore, it is critical to understand when a court will pierce the corporate veil.
So, when do courts pierce the corporate veil?
One: there is no true separation between the company and its owners. If the owners fail to maintain formal legal separation between their business and their personal finances, the corporation is just a sham and the owners are personally operating the business as if the corporation didn’t exist. In this situation, the corporation is the “alter ego” of it’s owner(s). Examples of this include an owner paying personal bills from the business checking account, ignoring legal formalities that a corporation must follow (such as recording important corporate decisions in the minutes of a meeting), not holding shareholder meetings (even if there is only one shareholder), and generally not acting like a corporation. In these situations, a court could decide that the owners are not entitled to limited liability protection.
Two: fraudulent or wrongful conduct by the company. If the company’s owners acted recklessly or dishonestly, a court could decide that limited liability protection should not apply.
Three: The companies creditors suffered an unjust cost. In the event a corporation is the “alter ego” of its owner, and the company’s actions were wrongful or fraudulent, a court will try to prevent injustice or unfairness by piercing the corporate veil.
Factors courts consider when piercing the corporate veil include:
One: whether the corporation engaged in fraudulent behavior.
Two: whether the corporation failed to follow corporate formalities.
Three: whether the corporation was adequately capitalized and had enough funds to operate.
Four: whether one person or small group of people were in complete control of the corporation.
Again, small corporations are particularly vulnerable to piercing. Owner operators need to be particularly concerned about this. Even though you are the sole owner and shareholder of the corporation, you still need to follow corporate formalities. Specifically, you need to hold annual meetings of directors and shareholders, keep accurate and detailed records of important decisions, adopt company bylaws, and abide by those bylaws. Do not commingle assets. The corporation should maintain its own bank account and the owner should never use the company account to pay for personal expenses.
You can protect yourself against a court piercing your corporate veil by:
Following the rules for forming and maintaining a corporation.
Maintaining a separate bank account for the corporation.
Do not use corporate assets for personal use.
Making a reasonable initial investment in the corporation.
Do not personally guarantee corporate debts.
Do not use the corporation for illegal, fraudulent or reckless acts.
Do not commingle personal assets with corporate assets.
Letting the world to know they are dealing with a corporation. Put “inc.” On business cards, letterhead, invoices, email, etc. when signing company documents, make it clear you’re doing so in your representative capacity; e.g.: president, vice president, secretary, etc.
What the Courts look for to determine if the corporate wall of protection stands:
“The basic rule stated by [the California] Supreme Court as a guide in the application of [the] doctrine [of alter ego] is as follows: The two requirements are (1) that there be such unity of interest and ownership that the separate personalities of the corporation and the individual no longer exist, and (2) that, if the acts are treated as those of the corporation alone, an inequitable result will follow” (Associated Vendors, Inc. v. Oakland Meat Co. (1962) 210 Cal.App.2d 825, 837.) The familiar litany of factors showing alter ego include:
the commingling of funds;
unauthorized diversion of corporate funds to other than corporate uses;
treatment by an individual of the assets of the corporation as his own;
failure to maintain minutes or adequate corporate records;
identical equitable ownership in entities;
failure to adequately capitalize corporation;
absence of corporate assets and undercapitalization;
use of a corporation as a mere shell, instrumentality or conduit for a single venture or the business of an individual;
diversion of assets from a corporation by or to a stockholder or other person or entity, to the detriment of creditors;
the manipulation of assets and liabilities between entities so as to concentrate the assets in one and the liabilities in another;
contracting with another with intent to avoid performance by use of a corporate entity as a shield against personal liability;
and “use of a corporation to transfer to it the existing liability of another person or entity.” (Id. at pp. 838-840.)
The Court held that the following allegations were adequate to state a cause of action against the defendant on an alter ego theory: “that the individuals . . . ‘dominated’ the affairs of the corporation; that a ‘unity of interest and ownership’ existed between respondent and the corporation; that the corporation is a ‘mere shell and naked framework’ for individual manipulations; that its income was diverted to the use of the individuals and respondent; that the corporation was, in effect, inadequately capitalized; that the corporation failed to issue stock and to abide by the formalities of corporate existence; that the corporation is and has been insolvent; and that adherence to the fiction of separate corporate existence would, under the circumstances, promote injustice.” (First Western, 267 Cal.App.2d at pp. 915-916.) The court held that assuming those facts could be proved, the shareholders of the corporation “may be held liable as principals or partners under the alter ego principle.” (Id. at p. 916.)
The laws regarding Piercing the Corporate Veil and “Alter Ego” are complex. A 1-2 hour consultation with
is time and money well spent to determine whether your Trucking Company can withstand attack and protect its owners from from being liable for its debts.