What is The Meaning of the Term Corporate Veil? How to Maintain the Corporate Veil?

What is the meaning of the term corporate veil? What is its origin? How to maintain the corporate veil? 

Meaning of the Corporate Veil

Limited Liability: The primary purpose of the corporate veil is to provide limited liability to the shareholders. This means that shareholders can only lose the amount they invested in the corporation, and their personal assets are protected from creditors of the corporation.

Legal Entity Distinction: The corporation is recognized as a separate legal entity from its shareholders. It can own property, enter contracts, sue, and be sued independently of the individuals who own it.

Piercing the Corporate Veil

(A) In some cases, courts may decide to “pierce the corporate veil.” This means that the court disregards the corporation’s separate legal status and holds the shareholders personally liable for the corporation’s debts or obligations. This typically happens in cases of fraud, illegal activities, or when the corporation is used to perpetrate injustice or circumvent the law.

(B) Factors that may lead to piercing the corporate veil include:

Commingling of Assets: Mixing personal and corporate assets.

Undercapitalization: Establishing a corporation with insufficient capital to meet its obligations.

Failure to Observe Corporate Formalities: Not following the required corporate procedures, such as holding meetings or keeping proper records.

Origin of the Term “Corporate Veil”

Legal Development: The concept of the corporate veil is rooted in the development of corporate law, particularly in the United States and the United Kingdom, during the 19th and early 20th centuries. It emerged as courts and legislatures began to recognize corporations as separate legal entities distinct from their owners.

Case Law: The term itself is often associated with the legal doctrines established in key court cases that set the precedent for recognizing the separate legal personality of corporations. One of the foundational cases in U.S. law is Salomon v. A. Salomon & Co. Ltd. (1897) in the United Kingdom, where the House of Lords affirmed that a corporation is a separate legal entity from its shareholders.

Historical Context

Economic Growth: The rise of the corporate veil concept coincided with the industrial revolution and the expansion of commerce, where limited liability encouraged investment by reducing personal risk.

Legal Evolution: As corporations became more common, the law evolved to provide protections for investors while ensuring that corporations could function as separate entities in the legal and economic landscape.

In summary, the corporate veil is a fundamental concept in corporate law that ensures the separation of a corporation’s legal identity from its shareholders, providing limited liability protection. Its origins lie in the evolution of legal principles that recognized corporations as independent legal entities, distinct from the individuals who own them.

How to maintain the corporate veil?

Maintaining the corporate veil is important for ensuring that the limited liability protection provided by the corporate structure remains intact. If the corporate veil is “pierced,” shareholders could be held personally liable for the company’s debts and obligations. To avoid this, corporations must adhere to certain practices and formalities that reinforce the distinction between the corporation and its owners.

Here are the key steps to maintain the corporate veil:

1. Observe Corporate Formalities

Hold Regular Meetings: Corporations are required to hold regular meetings for both shareholders and directors. Minutes of these meetings should be properly recorded and maintained.

Document Decisions: Major corporate decisions, such as issuing stock, entering into significant contracts, or taking on large debts, should be formally documented through resolutions passed by the board of directors.

Maintain Corporate Records: Keep detailed and accurate records of all corporate activities, including bylaws, articles of incorporation, minutes of meetings, resolutions, financial statements, and stock records.

2. Maintain Separate Financial Accounts

Separate Bank Accounts: The corporation should have its own bank accounts and should not commingle corporate funds with personal funds. All business transactions should be conducted through the corporation’s accounts.

Proper Accounting Practices: Maintain separate and accurate financial records for the corporation. Do not pay personal expenses with corporate funds or vice versa.

Adequate Capitalization: Ensure that the corporation is adequately capitalized at the time of formation and continues to be adequately funded to meet its obligations. Under-capitalization can be a factor in piercing the corporate veil.

3. Comply with Legal Requirements

File Required Documents: Submit all necessary filings with state and federal authorities, including annual reports, tax returns, and other compliance documents.

Obtain Necessary Licenses: Ensure that the corporation holds all required business licenses and permits for its operations.

4. Avoid Commingling Assets

Keep Personal and Corporate Assets Separate: Do not use corporate property for personal use without proper documentation and reimbursement to the corporation. Likewise, do not use personal assets for corporate purposes without formal agreements or leases.

Loan Documentation: If shareholders lend money to the corporation or borrow from it, these transactions should be properly documented with formal loan agreements, including repayment terms and interest rates.

5. Properly Issue and Track Shares

Stock Issuance: Issue stock certificates to shareholders and keep an updated record of all stockholders, including the number of shares owned by each.

Document Ownership Changes: Any changes in ownership, such as the sale or transfer of shares, should be properly documented.

6. Act in the Corporation’s Best Interest

Avoid Conflicts of Interest: Directors and officers should avoid conflicts of interest and always act in the best interests of the corporation. If a conflict arises, it should be disclosed and addressed according to corporate governance rules.

Sign Contracts Properly: When signing contracts or other legal documents on behalf of the corporation, use the corporation’s name and indicate your role (e.g., “John Doe, President, XYZ Corporation”) to clearly establish that you are acting on behalf of the corporation and not personally.

7. Maintain Proper Insurance

Liability Insurance: Maintain appropriate levels of insurance coverage for the corporation, such as general liability, product liability, and director and officer liability insurance. This helps protect the corporation’s assets and reinforces the separation between the corporation and its owners.

8. Comply with Tax Obligations

File Corporate Taxes: Ensure that the corporation files its own tax returns and pays any taxes due. Avoid any practices that could blur the line between the corporation’s financial obligations and those of its shareholders.

9. Respect Corporate Independence

Avoid Personal Guarantees: Where possible, avoid personally guaranteeing corporate debts. Personal guarantees can blur the line between the corporation and the individual, which could potentially lead to piercing the corporate veil.

Clearly Define Business Relationships: Clearly distinguish between the corporation and any related entities or individuals in business dealings.

By adhering to these practices, a corporation can maintain the integrity of the corporate veil, thus ensuring that shareholders continue to benefit from limited liability protection. Failure to maintain the corporate veil can result in personal liability for the corporation’s obligations, making these steps important for both legal and financial protection.

If you have all of the sections to a properly set up LLC and you maintain it, you will benefit not only with asset protection but also in the following ways:

(a) Increase your audit protection with IRS

(b) Get you more tax write offs

(c) Help you create a board of advisors for support