Many attorneys know that piercing the corporate veil is a concept used by Colorado courts to set aside the corporate protection (LLC or Corporation) to hold the owners of the Company personally liable. Studies show that most small, closely held Colorado corporations and LLCs would not withstand the challenge of a lawsuit or IRS audit. “Why not?,” you may ask, “I thought a corporation or LLC would protect me from liability.” A corporation or LLC will protect you from liability, but only if you follow the “corporate formalities.” If not, you could end up be held liable because of the concept of piercing the corporate veil.
There is a three part test under Colorado law to determine whether it is appropriate for a court to allow the piercing of the corporate veil. First, the court determines whether the Company is the “alter ego” of the person or entity. Second, the court determines whether the use of the company was used to perpetrate a fraud or defeat a rightful claim. Finally, the court considers whether an equitable result will be achieved by disregarding the Company form and holding the owner personally liable for the acts of the Company.
In a recent Colorado appellate case called, McCallum Family LLC v. Winger, Case No. 09CA0212 (Colo. App. Oct. 29, 2009), the court allowed permitting piercing the corporate veil on a single member LLC. While basically skipping through the three party test, the court focused its analysis heavily on the lack of formalities the LLC had exhibited. While alarming that the court allowed piercing the corporate veil so easily, it does underline the importance of following the proper corporate formalities to avoid piercing the corporate veil.
Use the following as a checklist if you have a Colorado corporation:
- Did you hold organizational meeting and appoint a board of directors?
- Did your board of directors appoint officers?
- Do you have written minutes of these meetings?
- Do you have a Federal Tax ID number?
- Did you physically issue the shares of stock?
- Does your corporation have its own bank account?
- Do you “commingle” your personal funds with your corporate funds (i.e., do you use the corporate checkbook to purchase personal items and vice-versa)?
- Does your corporation have a business license?
- A telephone in its own name?
- A physical office address with a written lease?
- Do you have annual meetings of the shareholders and board of directors?
- Do you have written minutes of these meetings?
- Do you sign all of your leases, contracts and letters in the capacity which you are acting? (e.g., “President” or “Secretary”).
An LLC in Colorado does not necessarily require shares of stock issued or by laws, but it does need a well-drafted operating agreement.
Your failure to follow one or more of these formalities may result in piercing the corporate veil by a court like the Winger case. This is a legal expression for the process by which a court can actually penetrate the invisible wall of protection between you and your corporation and permit a creditor to go after you personally. Let me ask you a question . . . do you think IBM violates any of the above mentioned items?
The lesson here is that if you want to be treated like a legitimate corporation, then act like one! Go dust off that big, black corporate minute book that you tossed in the closet years ago. Look through the forms. It’s not “rocket science” . . . it’s simply a matter of keeping records in case of a lawsuit or IRS audit. You don’t need to run your corporation with rigidity, you simply need a “paper trail”to justify what you are doing.
Here are a few tips:
- If you use your spare bedroom as an office, have written lease between you and your corporation. Make it a “net” lease, so that your corporation can pay you for its share of the utilities, taxes and insurance on your home.
- If you a constantly “funnel” money between your personal and corporation bank accounts, draw up a line of credit agreement between you and your corporation. That way, the “piecemeal” payments that go back and forth will appear perfectly normal (after all, isn’t that what you do with a credit card account?).
- If you need a legitimate office and phone, consider an “executive suite.” There are companies that will rent you an office address with answering service for as little as $75/month. This will not only give your corporation legal legitimacy, but it will give you a place to meet an occasional client
Do not wait until you are sued or audited to “backdate” the paperwork! If you get caught (and you will), you’ll find yourself in a legal mess that attorneys just drooooool over! Don’t let piercing the corporate veil happen you to – meet with a qualified attorney to review your corporate paperwork and practices for compliance. For a nominal fee we charge, you can make sure you are really protected. An ounce of prevention is worth a pound of regret!