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THE LAW FIRM FOR ENTREPRENEURS

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Piercing the corporate veil - avoid the appearance of evil

The primary benefit of creating a business entity for your business is to gain limited personal liability. If properly created and maintained, it is the business that is exposed to liability, not you the business owner. Prior to the advent of limited liability business structures in the early 1800’s, each business owner was personally responsible for all of the debts of the business. As a result, there was huge risk any time someone started a new business as its failure could result in financial ruin. With the adoption of limited liability structures, it became possible to start a business, and, if it failed, suffer the personal loss of no more than was put into the business.

The limited liability protections of a business entity come with caveats, however. If the limited liability protections were granted without question, it could result in rampant fraud and abuse of the system. We can all imagine the unscrupulous people who would run their ponzi schemes through a limited liability business entity only to leave the victims holding the bag while the limited liability protection kept the fraudster from any personal consequences. In order to prevent that, courts are permitted to “pierce the corporate veil” of a business entity and hold the owner(s) of the entity personally responsible for the liabilities of the business if the court believes the business is not operating in good faith. In Utah the courts have many factors they consider, but some examples include undercapitalization of the business, failure to observe business formalities, absence of business records, and treating the business as an owner’s “alter ego” i.e. using business credit cards to buy personal items, taking money from business accounts to pay personal bills, etc.

Because of this doctrine, it is important to religiously follow business formalities and best practices in order to avoid even the appearance of evil, so to speak. Should the business fail and disgruntled creditors, partners, or employees come calling they inevitably raise the specter of “piercing the corporate veil” and holding the owner(s) personally liable. Very expensive litigation can be avoided or dramatically shortened by abiding by best practices and observing recording the observance of business formalities. If you don’t know what are best practices or what business formalities need to be observed, consult an attorney.

Craig WinderBasics