When individuals form business entities, generally they choose entities that allow them to limit their personal liability, leaving only the entities’ assets vulnerable to lawsuits. For corporations and Limited Liability Companies (LLC), the business entities are separate from the corporate officers and shareholders (or LLC members), and these individuals are typically not liable for the entities’ debts. However, there are instances where individuals may be liable for corporate debts, even if the corporation, and not the individual, is the target of a lawsuit.
The recently decided case, Virginia Electric & Power Co. v. Peters, highlights the importance of taking steps to avoid the possibility of piercing the corporate veil and the resulting personal liability. In Virginia Electric & Power, Dominion Virginia Power (“Dominion”) sued Bransen Energy Inc. (“Bransen”) and obtained a $24.5 million judgment against Bransen. However, Dominion wasn’t able to collect on the judgment and brought another action to pierce Bransen’s corporate veil and impose liability on Michael Peters (“Peters”), Bransen’s owner and sole shareholder.
Peters was Bransen’s president, owner, and sole shareholder and used more than $2.66 million of Bransen’s funds for his personal benefit. Additionally, after Peters knew Bransen had breached its contract with Dominion, he and his family “used Bransen as a personal checking account,” writing checks from the account without any business connection to the company. Peters also created new companies and funded them with Bransen’s funds, even though the new companies had no connection to Bransen. The court found that Peters “used the corporate structure to avoid liability to Dominion by making corporate decisions that benefits him and not his corporation” and that Peters may be personally liable for Bransen’s debt to Dominion.
When trying to pierce the corporate veil, courts have personal jurisdiction over individuals if the individual is the “alter ego” of the corporation. When deciding whether an individual is an “alter ego” of the corporation, the court must determine whether the individual exercised “undue dominion and control over the corporation,” such that “the corporation was a device or sham used to disguise wrongs, obscure fraud, or conceal crime.” Perpetual Real Estate Servs., Inc. v. Michaelson Properties, Inc., 974 F.2d 545, 548 (4th Cir. 1992). When determining whether this undue dominion and control existed, the court may consider whether the individual observed corporate formalities, kept corporate records, paid dividends and whether there were officers and directors. Essentially, the court must determine whether the individual misused the corporate identity to disguise assets.
Once the corporate veil is pierced, a business owner may be personally liable for debts of the corporation. The possibility of piercing the corporate veil is a particular concern for closely held businesses. Business owners should understand the concept of piercing the corporate veil to minimize their own risk by structuring and operating their business entities in an appropriate manner. Below are a few practical tips for business owners to utilize to create the best possibility of avoiding personal liability:
- Observe Corporate Formalities – If your business has a board of directors (or managers) hold regular meetings and document and keep the minutes of those meetings. Additionally, business owners should have governing documents for their entities, such as operating agreements and bylaws.
- Keep Separate Records and Bank Accounts – It is important that business owners treat the entities as truly separate, especially when it comes to the entities’ assets. Don’t commingle funds or borrow from the company to pay personal expenses. Contribute all business profits into and pay all business expenses from the entity’s bank account and keep business financial records separate from personal financial records.
- Operate at Arms-Length – When engaging in transactions that may appear inappropriate to unrelated parties, take care to follow proper protocol. For example, if you plan to contribute personal assets to the entity as a capital contribution, document the transfer. If you own multiple entities that provide services to the other, have contracts in place governing those relationships. When in doubt about whether a transaction is appropriate, err on the side of caution.
A court’s decision to pierce the corporate veil is decided on a case-by-case basis and generally results from a combination of factors with an added element of injustice. Unfortunately, there is no guarantee that a business owner will avoid personal liability for business debts, but there are ways to conduct your business now to put yourself in the best position later, in the event a legal situation arises. The most important thing to remember when conducting a business is to maintain and document the level of separation between entity and owner and always treat the entity as distinct.
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Attorneys at General Counsel PC are specialized in business law and have experience working with business owners across Virginia, specifically in Fairfax County, Arlington, Loudoun County, and Prince William. If you’re currently facing a legal issue that’s putting your business at risk or you’re looking for legal advice on the strength of your business protections, General Counsel PC has the expertise you need. For more information about how you can ensure your business is protected, call General Counsel PC at 703-556-0411 today.