Three Steps to Limit Liability and Avoid Veil Piercing

A corporation is a separate entity with its own liabilities for which the individual owners cannot be held personally liable. It is a concept that is old as dirt and right as rain, right? Surely everyone accepts this basic premise of doing business as a corporate entity?  Well, perhaps everyone but the plaintiff’s attorney seeking to hold someone with deep pockets financially responsible for his client’s injuries.

As old as the concept of limited liability is, there is another concept that is just as old.  While usually the individual owners of a corporation are not held personally liable for the corporation’s liabilities (i.e., limited liability), a court may ultimately determine it is fair and equitable to pierce the corporate veil and hold the individual owners personally liable (i.e., veil piercing).  The good news for owners of a corporation is that courts will tend to respect the corporate veil if the owners do as well.  Here are three steps that will help ensure your corporation stays cloaked in limited liability and away from the dreaded veil piercing:

1. Pay attention to corporate formalities:  It appears to be an obvious point, but it is often given short shrift, especially by serial inventors and owners of several businesses.  It is very important for purposes of ensuring limited liability that owners, directors and managers of corporations practice the traditional corporate formalities at all times.  These include: conducting regularly noticed directors’ and stockholders’ meetings; documenting formal approval of corporate actions; keeping adequate books and records; and maintaining separate bank accounts. Keep separate finances for the corporation versus its shareholders and do not commingle funds between the corporation and any other person or entity.

2. Keep the corporation well-capitalized:  A healthy, well-capitalized corporation with its own assets and liabilities will typically be respected by the courts.  If the corporation appears to be a shell with no legitimate business purpose or assets to offset its liabilities, the chances of a veil piercing are increased.

3. Do not use a corporation as a means to defraud creditors:  This one probably goes without saying too, but if there is an existing liability, reorganizing a corporation into separate new corporations in order to cleave going concerns from the bad, liability-ridden parts and somehow defraud the creditor is ultimately not a sound strategy.  At its heart, veil piercing is an equitable doctrine and where courts smell the manipulation of the corporate veil to avoid a liability that is otherwise due and owing, they are likely to find a way to hold those responsible for the fraud liable.

How to Prepare for an Equity Financing

We have covered in past FTTWs how to value your startup and how much capital to raise. Once your startup decides to pursue equity financing, you should start to prepare for the investor due diligence process. On the business side, you will need to prepare a business plan and should take steps such as obtaining management references, interviews and background reviews, customer/user references, technical/product reviews, financial statements and business model reviews.

What Every Startup Needs to Know

On Wednesday, June 26th, Perkins Coie’s Palo Alto office hosted the startupPerColator event, “What Every Startup Needs to Know.” Lowell Ness, a Perkins Coie partner in the Emerging Companies & Venture Capital (ECVC) practice, moderated a panel which included Herb Stephens of NueHealth, Thomas Huot of VantagePoint Capital, Jennifer Jones of Jennifer Jones and Partners, Yuri Rabinovich of Start-up Monthly, and Olga Rodstein of Shutterfly.