posted on 2014-02-20 by Dean Kaplan
We frequently
get asked by new clients about piercing the corporate veil on owner-operated
companies that go out of business owing money. Everyone's heard about someone
else piercing the veil to create personal liability for business debts and
getting paid. These 'stories' make it sound simple and a highly effective
method for debt collection.
Unfortunately,
this is more myth than reality. The truth is that it is so expensive and
uncertain to pierce the corporate veil that our clients rarely try.
One of the main reasons small business owners
incorporate or form an LLC (limited liability company) is to protect their
personal assets from the liabilities that their companies create. This legal
structure creates an entity separate from the individual. However, if the owner
co-mingles their personal financial transactions with their company
transactions, then you can argue that the company is not truly separate from
the individual. If you prevail in court with this argument, you have pierced
the corporate veil and the owner is now personally liable for the money the
business owes creditors.
Many (or most?)
small business owners will pay some personal expenses from the corporate
account since they are using pre-tax dollars and the expense reduces their tax
burden. Meals, memberships, family cell phones and gasoline purchases, and
subscriptions are common deductions. Others get more aggressive, paying home
utilities, credit card bills, and other home improvement expenses from the
business banking accounts. This may be by design to lower tax liabilities, or
simply sloppiness where the owner treats the business checking account as if it
was their personal money.
The problem in piercing the corporate veil is
we don't know to what extent this co-mingling has occurred without getting to
review all of the company's financial transactions. As described in this article by attorney Paul Porvaznik, we usually
cannot know if there are grounds to pierce the corporate veil until after we
have a judgment and it may even require a separate lawsuit. After getting a
judgment, a debtor examination can be scheduled where we look for evidence of
co-mingling. This can be easy if the
debtor’s check register is available and the payees on checks are indicative of
personal expenses.
But, it is
rarely this simple. Individuals have to
be personally served to appear at debtor exams.
This can be difficult, requiring multiple postponements and sometime
expensive stakeouts. They frequently
miss the exams so they have to be rescheduled multiple times, each one
requiring personal service to notify of the examination time. They do not always bring all the documentation,
requiring more rescheduling and appearances.
(See our 5 minute video on the judgment collection process for more
information).
If the check
register does not clearly show co-mingling transactions, further investigation
is required. All the company’s financial
records need to be obtained. A
professional needs to be hired to review the information and identify violating
transactions. This could cost as little as $2,000 or more than $25,000 for
larger owner-operated businesses. All
too often this process is stymied by the debtor claiming the records no longer
exist.
If we are
successful in getting evidence of co-mingling, we need to get back in front of the
judge. The case needs to be made that
the co-mingling is sufficient to pierce the veil and create personal
liability. This means more court fees,
hearings, and attorney time. And even if
we are successful, we still do not know if the business owner has personal
assets available to pay off the judgment.
If the business was their primary source of income, they may be under
severe financial distress for many years and therefore your judgment will not
get collected.
Many debt
collection litigation attorneys will not want to take cases like this on a pure
contingency basis unless there is strong evidence of eventual success. They know a lot of time and effort will be
required and only a very small percentage of cases will result in piercing the
veil AND finding personal assets that can be seized to pay the judgment.
At our
commercial collection agency, we advise clients that if they want to try to
pierce the corporate veil on marginal or difficult cases, they should be ready
to spend a minimum of $10,000 and it could easily run $25,000 to $75,000 in
complex cases where the debtor clearly has other personal and business
interests that they are trying to protect.
And there is no guaranty of success in piercing the veil and/or
ultimately collecting any money. Thus, this investment can only be justified
when very large amounts are owed, the individual has personal assets available
to pay the debt, and we have strong anecdotal suspicion of significant
co-mingling. Since all of these conditions are rarely met when we are asked
about piercing the veil, our clients rarely attempt it.
Recently I
wrote about a simple personal guaranty that has frequently
saved our client from significant losses. Despite all you may have heard about
piercing the corporate veil, if you don't get a personal guaranty in advance,
you probably won’t attempt to pierce the veil due to the cost and uncertainty. If you want the business owner’s personal
assets as a secondary source of repayment, get a personal guaranty.
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