The protection provided by a business entity can help incentivize individuals to take the risk of opening a business, because creating a separate entity can limit an individual's personal liability for actions of the business. By creating an entity, individual business owners are creating a theoretical “veil” between their personal assets and possible sources of liability that arise from the business. Developing a sufficient "veil" is a very important part of limiting personal liability. Courts have developed a complex list of elements that entities such as limited liability companies (LLCs) and corporations must meet in order to be given the protection of the business owner's chosen entity. A business must meet these elements in order to get the protection of the chosen entity. This means doing more than merely filing articles of incorporation with the Secretary of State.
If someone sues your business, she likely will try to “pierce the corporate veil” so that you as the business owner are held personally liable, thus increasing the amount of assets from which a plaintiff can collect. Piercing the veil can be easy if the business owner has not done his due diligence running his business. On the other hand, a business owner can strengthen his veil by running the business in accordance with Colorado statute and case law. This means that you should not simply create your entity and file your articles of incorporation, then forget about creating a corporate record book and other formalities. Those formalities are the reason your entity will protect you from liability, and without them your entity can easily be pierced by a potential plaintiff.
It is important for business owners to be aware that the question of piercing the corporate veil is an equitable one, meaning the that business owner cannot ask for a jury trial on the issue. Judges are given a great deal of discretion to decide this issue. This means that a ruling in favor of piercing the veil and allowing personal liability would be difficult to overturn on appeal. Here are some of the things you can do as a business owner to ensure your corporate veil will protect you in case of a law suit:
- ALWAYS sign your name: Your Name, Title, Company Name.
- Be sure that when you are acting on behalf of the business, the people you are dealing with know that you are the business's authorized agent.
- Only shareholders, directors, and officers should have control of the company. Allowing outside parties to have control over corporate decisions can allow the veil to be pierced.
- Do not use the entity to commit fraud.
- Do not use the entity as a mere instrumentality – be sure it is a functioning business.
- Be sure the corporation is “capitalized,” or funded, sufficiently for start-up costs.
- Books and records must be up-to-date and maintained. This also means that annual meetings must be held on the date stated in the bylaws or operating agreement. Minutes from those meetings must be kept in the corporate record book.
- The entity (not individual shareholders) enter into service contracts.
- The entity contracts for debt and pays the debt.
- The entity receives money due on debts owed to it.
- Keep good accounting records and do not commingle the entity's funds with the individual owner's personal finances.
These are just some of the things you can do as a business owner to ensure that your corporate veil is as strong as possible. In the case of parent and subsidiary companies, a plaintiff may seek to pierce the subsidiary's veil to attach liability to the parent company. The above factors become even more important in that situation and some additional factors are added.
We recommend that you consult an attorney regarding these and related issues no matter the size or complexity of your business. The above is an overview, and is NOT an exhaustive analysis of this complex legal issue. It is important to have an attorney involved at every major step of your entity's existence to be sure that the entity you chose will provide adequate liability protection.