The number one reason people hire an attorney (or should hire an attorney) to form a business entity like a corporation or limited liability company (LLC) is for personal liability protection. Clients do not want to put their personal assets at risk for the business’s liability.
If you have a corporation or LLC, personal liability protection is not guaranteed. When a creditor or plaintiff sues a corporation or LLC, it may try and “pierce the veil.” Piercing the veil means the creditor or plaintiff is trying to attach personal liability onto the corporation’s shareholders, officers, and directors or the limited liability company’s members, managers, and governors. Meaning, the creditor or plaintiff is trying to reach beyond your corporation’s or LLC’s assets to your personal assets to satisfy a judgment.
Here’s what the North Dakota Supreme Court has held on veil-piercing:
Although the officers and directors of a corporation generally are not liable for the ordinary debts of a corporation, the corporate veil may be pierced when the legal entity is used to defeat public convenience, justify wrong, protect fraud, or defend crime.
The factors to be considered when a court determines whether to pierce the corporate veil are set forth in Hilzendager v. Skwarok, 335 N.W.2d 768 (N.D.1983), and Jablonsky v. Klemm, 377 N.W.2d 560 (N.D.1985). In Hilzendager, 335 N.W.2d at 774, [the North Dakota Supreme Court] said:
[F]actors considered significant in determining whether or not to disregard the corporate entity include: insufficient capitalization for the purposes of the corporate undertaking, failure to observe corporate formalities, nonpayment of dividends, insolvency of the debtor corporation at the time of the transaction in question, siphoning of funds by the dominant shareholder, nonfunctioning of other officers and directors, absence of corporate records, and the existence of the corporation as merely a facade for individual dealings.
In Jablonsky, 377 N.W.2d at 564, [the North Dakota Supreme Court] added that “an element of injustice, inequity or fundamental unfairness must be present before a court may properly pierce the corporate veil.” 1415 [¶ 21]
In Intercept Corp., 2007 ND 180, ¶ 15, 741 N.W.2d 209 (citations omitted), we explained:
The burden of establishing the necessary elements for piercing the corporate veil rests on the party asserting the claim. Resolving the issue is heavily fact-specific and, therefore, is within the sound discretion of the district court. The court’s findings of fact are presumed to be correct and will be reversed on appeal only if they are clearly erroneous.
Coughlin Const. Co. v. Nu-Tec Indus., Inc., 2008 ND 163, ¶¶ 19-21, 755 N.W.2d 867, 873 (certain citations omitted).
Books have been written about what this actually means, and we cannot do this subject matter justice in such a short blog post. Instead, we’ll try and give our clients and readers practical recommendations. So, here are some low-cost ways to protect against piercing the veil:
Keep Good Books & Records
Meaning, you should keep good accounting books and records. If your books are a mess, you won’t be able to show that your corporation or LLC has been operating legitimately when tested. If you cannot distinguish between personal and corporate assets/expenditures, do not expect that a judge or jury will be able to, either.
Keep Your Minute Book Updated
A minute book is basically a journal of all corporate action. You should file your annual report with the North Dakota Secretary of State on time. Even if you are a single-member limited liability company, you should prepare and sign annual minutes. You should memorialize all material decisions in the minute book.
Do Not Commingle Assets
Use corporate assets only for corporate business. The more you use corporate assets for personal business, the higher the risk you have for veil piercing. Your corporation or LLC should have a separate business account used only for business expenses.
File Taxes Correctly
You likely will have to file a separate tax return for your limited liability company or corporation. Make sure the returns are filed correctly and taxes are paid.
Carry On As An LLC/Corporation
Appearances matter. If you have Bylaws or an Operating Agreement, you should follow the procedures outlined in those documents. Sign as president instead of just your own name. Maintain a space suitable for carrying on the business. Make sure you have enough capital to carry on your business. Have business cards. Network. Hire sufficient staff. Make money.
If you have any questions or would like a check-up on your business, please contact our Business Law Team at 701-297-2890 or send us an email below.