Two of the most frequent and related issues that arise with my clients are the extent to which: (1) proper incorporation protects individual business owners from personal liability, and (2) improper corporate governance by independently-contracted business partners creates unnecessary exposure for a well-run company. Among the principle benefits of incorporation are the many liability protections it affords to owners who are willing to invest capital, take risks and grow new businesses. Likewise, large companies vetting new business partners and suppliers care immensely whether the entity on the other side of a commercial transaction is a properly functioning business and a true independent contractor.
Depending on the choice of business entity, incorporation provides important liability protections for business owners when corporate formalities are properly observed. This “shield” from personal liability is not absolute and there are important exceptions, including many forms of professional malpractice and certain employment actions. Nevertheless, all businesses should be aware of the types of practices (or lack thereof) that jeopardize the liability protections afforded by the corporate form or generally risk exposure in other areas.
Piercing the Corporate Veil
Most courts are reluctant to “pierce the corporate veil” and subject owners to personal liability for otherwise insulated corporate acts or omissions unless it is shown that the company fails to operate as an entity distinct from its owners and does not respect basic corporate legal formalities. Specific factors that courts may examine for this analysis include the following:
(1) whether the company observes corporate formalities;
(2) whether there is any diversion of or “commingling” of funds or other property of the company for personal use by the owners;
(3) whether corporate records are regularly and adequately maintained; and
(4) whether the company acts as a mere “facade” or “alter ego” of its owners.
Importantly, failure to observe basic corporate formalities is frequently symptomatic of a business’s exposure across a broad range of areas (e.g., employment law, creditworthiness, taxation, compliance, etc.). Seeking assistance from experienced legal counsel can help to avoid or mitigate many of these risks.
If you need legal help with business formation, commercial contracts or want to better understand your options with respect to a business dispute, please contact Mulhall Zion LLC at (216) 586-4278 in Ohio, or (240) 630-0407 in Maryland.
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