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Legal Issues

In an extension of last month's "Legal Issues" article on the types of business entities, this article is going to elaborate on the corporation aspect.

Most people understand that a "corporation" offers some type of protection; however, what is often misunderstood is the nature of the protection a corporation provides. To protect your company and yourself, you need to understand the nature and limits of the protection of a corporate shield from liability. Further, there are a number of ways that the corporate shield can be pierced. This article will discuss how there are a number of simple steps to avoid someone "piercing the corporate veil."

What is a Corporation?
A corporation is a legal entity separate and apart from its owners, officers, directors and employees. By filing the appropriate papers with your applicable governmental entity, you can create a separate legal entity. The courts view this entity as a separate entity that is able to enter into its own obligations and that is subject to enforcement of those obligations.

The key point here is the law views the corporation as separate. As a general matter, courts will not allow an officer, director, shareholder or employee to be personally liable for the corporation's obligations, liabilities or debts. This doctrine is often called a "corporate shield" from personal liability.

Individual Wrongful Conduct
While the corporate shield insulates owners from liability for corporate obligations, a corporation does not translate to a "free pass" on your own personal wrongful conduct. You may still be held liable for your own torts. Thus, if you commit fraud, you are still personally liable.

Similarly, negligence claims sound in tort. If you are driving the company car and get into an accident, you are still personally liable if you are negligent. The company may also be vicariously liable if the accident occurs within the scope of employment. The main protection of corporations is against contract liability.

One area where a corporation may protect you individually from tort liability is for the torts of others. For example, if an employee is negligent and gets into a car accident, that employee may be liable. Again, if the accident occurred within the scope of employment, the corporation may be liable. The other individual officers, directors and shareholders would likely be insulated from personal liability if they were not personally negligent.

Typical Methods of "Piercing the Corporate Veil"
There are several tried and true ways of "piercing the corporate veil" to impose personal liability. If a corporation is viewed as a "fraud," "sham" or an "alter ego" of the individual shareholders, the court may dispense with the legal fiction that the corporation is a separate legal entity. These situations would permit direct causes of action against the shareholders.

There are key repetitive factors that courts look at when analyzing these questions. Commingling of business assets and personal assets is the easiest way to demonstrate the corporation is not in fact separate from its ownership. It is critical to maintain separate bank accounts. You should not use corporate accounts to pay for personal debts and liabilities. Transactions between shareholders and the corporation should always be handled at arm's length and documented clearly.

Another similar test for piercing the corporate veil comes from not observing corporate formalities. Bylaws for most corporations establish annual meetings of shareholders and boards of directors. You need to hold these meetings and create minutes to document decisions made at the meetings. You should adhere to all formalities called for in your corporate documents.

Identifying the Corporation
Perhaps the most common — and ultimately most mind-boggling — erosion of corporate protection lies in properly identifying corporate entities. I have handled numerous cases where a corporate entity failed to properly identify itself. If you are a corporation, the proper name and status must be disclosed on all advertisements, phone listings, business cards and stationary.

If your company enters into a contract, the contract should properly list the parties and their correct names. A failure to include the corporation's name can be the kiss of death to the corporate shield from personal liability.

Creating a corporation is the cheapest way to avoid personal liability available under the law. While corporations are not a complete panacea, they can be excellent tools to protect personal assets. You should understand what corporations protect you from, and what erodes those protections, to ensure your corporation offers you the best refuge possible.



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