A limited liability company (also called an “LLC”) combines the limited liability benefits of a corporation with the management and tax structures of a partnership. This business structure protects members of the LLC from any creditor or legal claims against the company.

Essentially, creditors cannot seek damages from the individual members if their claim is against the company itself. However, even limited liability does not shield owners or directors from their own negligence.

While limited liability is a great benefit to organizing your company as an LLC, there are some instances when courts will allow creditors to bypass the company and hold the LLC’s owners, members, and shareholders personally responsible for business debts. This is called “piercing the corporate veil.”

Why Would You Need to Pierce the Corporate Veil?

Usually, an advantage of having an LLC is to limit the owner’s liability when it comes to unpaid debts. A creditor trying to sue the company for unpaid debts would normally be limited to a claim against the assets of the company. However, if the LLC is unable to pay its debts, creditors may try to pierce the corporate veil in order to be able to go after the assets of the LLC’s owners.

How Do You Pierce the Corporate Veil?

If you have provided goods or services to a company and have not been paid, you may want to try suing for payment. However, if the company is defunct, has closed down, or has dissolved and has no assets, then it may be difficult or impossible to collect payment from the company itself. But, the former company’s owners may still have assets—and piercing the corporate veil in order to collect payment may be the next appropriate step.

Courts will often consider a variety of factors when determining whether piercing the corporate veil is appropriate. If you find yourself in a situation like this, then you may want to discuss with a qualified business attorney the best way to approach the situation. Often, courts will consider:

  • Whether the LLC engaged in fraudulent behavior;
  • Whether the LLC failed to follow corporate formalities or company rules;
  • Whether the LLC was properly capitalized;
  • Whether one person or a small group of closely related people were in complete control of the company; and/or
  • Whether owners used personal funds for company expenses, or whether owners used company funds for personal expenses

If the LLC was not property capitalized, if it never had enough funds to operate independently, the court may find that it was not really a separate entity with the ability to stand on its own (and thus an extension of the owners).

What Happens If the Court Takes the LLC Status of My Company?

If the court determines that the LLC is a sham company, then the company’s limited liability status may be stripped away. Members of the LLC can be held personally liable for company debts.

The company’s creditors will then have the legal right to sue any owners, stockholders, directors, or board members directly for the payment of company debts. However, the courts may limit personal liability to those individuals who are responsible for the company’s wrongful actions.

How Can I Avoid Piercing the Corporate Veil?

There are several things that owners, directors, and stockholders can do to avoid losing a company’s limited liability status. Specifically, you want to make sure that all business assets remain separate and apart from your personal assets. To do so, pay attention to the money and assets:

  • Don’t commingle personal assets with LLC assets. Business accounts and personal accounts should remain separate, and you should not be funding one account with money from the other.
  • Don’t divert LLC assets into personal accounts. If funds or assets are intended for business use, they must be deposited into business accounts dedicated to the LLC.
  • Don’t use the LLC’s money for personal use. This also includes company credit cards or lines of credit. If you are using company money to fund your personal lifestyle, this can create a problem for you if you have creditors seeking to pierce the corporate veil.
  • Don’t personally guarantee a creditor payment for LLC debts. If you give a personal guarantee, this allows a creditor to pursue you directly as an individual for the payment, rather than going through the LLC.

What Should I Do To Keep My Company’s LLC Status?

To keep the company’s limited liability status, there are a few things that you can do. First, you want to make sure that you make a reasonable first investment in the LLC so that it is properly capitalized—that way, you do not have to continually funnel personal assets into LLC accounts to keep it funded. This avoids the appearance of commingling of personal and business funds.

Second, it is also important to keep separate accounts for your personal and business assets. Keeping separate accounts also helps to avoid commingling funds, and you can keep better track (and more easily keep track) of the business financials.

Make it clear to creditors, other businesses, and customers that the business is an LLC. This alerts others working with you to your limited liability status.

Finally, it is a good idea maintain formal rules when starting and maintaining your LLC. If you have formal written rules in place when it comes to the finances and procedures of the company, this can serve as a layer of protection when creditors come knocking.

Can I Still Be Sued For My LLC’s Debt?

Owners, stockholders, and directors of the company can be sued for the LLC’s unpaid debts. However, just because a creditor files a lawsuit does not guarantee their success. If you have acted to protect the LLC status of the company, chances are that the court will only allow the creditor to recover what they are owed through the LLC’s assets.

Do I Need a Lawyer If I am Worried About My LLC?

If you are a member of an LLC and are concerned about keeping your company’s limited liability status, you may want to consult a qualified business lawyer. A business lawyer can discuss your business matters with you and provide advice on the best way to proceed if you are running into a situation with creditors.