If you formed an LLC and think you can’t be sued for anything related to your business operations, you are dead wrong.
Many founders are unaware that their everyday actions can erode the legal line between themselves and their company, putting their personal wealth at risk.
Forming an LLC or corporation isn’t enough.
You need to know how to use the structure to proactively protect your assets.
This guide provides a clear explanation for business owners on the protection a corporate entity offers, what the “corporate veil” is, and some practical steps you can use to protect your personal assets.
The primary reason to form a corporation or LLC is to create a legal entity separate from its owners. This concept is called limited liability.
It means the business entity itself is responsible for its own debts and legal obligations.
Creditors of the business can pursue the company’s assets, but not the personal assets of its owners, like your home.
While that concept is generally true, there are limits. And they are critical to understand.
If you don’t, you cannot effectively use the entities protect yourself.
In most circumstances, corporate entities will not protect you from your own negligence.
As a general rule, you will always be responsible for your own negligence.
For example, if you are the owner and you cause a traffic accident while on the job, you will almost certainly be sued personally for the injuries. Even though you were on the job, you are still responsible for your own actions.
Piercing the corporate veil is a legal doctrine that allows a court to disregard the limited liability protection of a corporation and hold its owners personally responsible for the corporate debt.
When this happens, the legal separation between you and your business vanishes, putting your personal assets on the line.
In Illinois, courts use a two-part test to determine if the corporate veil should be pierced:
To ensure your personal assets remain protected, you must avoid the common mistakes that lead a court to find a "unity of interest."
Here are some of the biggest red flags to look out for.
This is one of the most common and damaging mistakes.
The commingling of funds in a corporation happens when the owner treats the company bank account like their personal bank account.
Business owners need to maintain both business bank accounts and personal bank accounts separate from each other. Using business funds to pay personal expenses makes it much more likely a court will disregard the corporate structure.
A good way to think about this is that the business entity actually is a separate person.
You wouldn’t steal from your neighbor’s bank account to pay for your personal expenses. The same applies to the business.
Illinois law sets forth rules that business entities must follow to maintain their corporate protection.
The specifics differ based upon the type of entity, whether corporation or LLC, but in both cases, there are formalities that must be followed.
With respect to corporations, some of those formalities include:
LLCs, on the other hand, are not required to adhere to the strict statutory requirements of corporations. However, LLCs should still:
A business must be set up with adequate capital to handle its expected debts and operational costs.
If a company is intentionally underfunded from the start, a court may conclude it was never intended to be a legitimate, separate entity capable of paying its own bills.
This is especially true if any of the other factors discussed here are also present.
For owners who operate multiple business entities, courts will scrutinize how those companies interact with one another. The legal separation between the companies must always be respected.
The core principle is that each company must operate at "arm's length," meaning it should transact with a sister company just as it would with any unrelated third party. This includes:
When you fail to treat your companies as distinct, a court may view them as a single enterprise, potentially exposing the assets of a healthy business to the liabilities of another.
The limited liability provided by a corporation or LLC is one of the most powerful tools available to a business owner. However, this protection is not absolute.
Proper corporate governance can be a headache, but it is the work necessary to protect the valuable enterprise you are building.
If you are ready to ensure your business is built on a solid legal foundation, our team is ready to help.
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Disclaimer: The information contained in this article has been prepared by Small Business Legal Solutions LLC for general informational purposes only. Nothing in this article is intended to constitute legal advice on any subject matter. The materials in this article are not intended to and do not create an attorney-client relationship. Do not act or refrain to act based on any information contained in this article without first personally consulting with an attorney. Every circumstance is different and must be judged on its own merits.