Protecting Your Business and Personal Assets in a Difficult Economy

In today's difficult economic climate, businesses and their owners face increase risk of being sued. Given this risk, business owners should do all they can to minimize exposure of their personal assets with respect to possible liability resulting from these lawsuits.

Typically, incorporating a business is an effective means of protecting a business owner's personal assets from exposure to claims against his/her business. However, simply incorporating the business alone will not protect personal assets if the business has not complied with the formalities and requirements that the law requires of a corporation. When a business owner neglects those requirements, courts sometimes "pierce the corporate veil" allowing a business owner's personal assets to be exposed in satisfying claims against the business. Essentially, when the courts allow piercing of a corporate veil, the business owner has lost all protection of the corporation entity form.

The term "piercing the corporate veil" basically means that the law treats the business owner and the business owner's assets as one complete entity, making the owners personal assets subject to liabilities incurred by the company. In those situations, the corporation is basically seen as a mere alter ego of the business owner.

Michigan courts look to three elements needed to pierce a company's corporate veil:

  1. Is the corporate entity operating as a mere alter ego of another entity or individual, meaning the business is being used in furtherance of another purpose rather than its stated mission?
  2. Is the corporate entity being used to commit fraud or wrong doing?
  3. A plaintiff in a lawsuit suffered an unjust loss or injury if recovery is limited only to the business and cannot extend to a business owner's personal assets.

Fortunately, under Michigan law, only extraordinary circumstances justify a disregarding of a corporate entity exposing the owner to personal liability; however, that is not to say that a business owner will never be subjected to such a claim, especially in these unprecedented economic times.

Historically, Michigan courts in evaluating the aforementioned prerequisites look to a number of factors to decide whether these factors have been met and a corporate veil should be pierced.

The court looks to whether:

  • the corporation is under capitalized (lacks sufficient funds to pay its bills);
  • corporate books have, or have not, been maintained;
  • there is a separation between individual and corporate finances;
  • the corporation is used to support fraud or illegality;
  • the corporation formalities have been honored especially with respect to complying with the terms and conditions of the Michigan Corporation Act, and
  • the corporation has paid excessive dividends to its shareholders.

Where the court decides that a plaintiff's claim meets the prerequisites to pierce the corporation, the court will find an abuse of the corporate form and allow a claim against the corporation to pass through and attach to a business owner's personal assets.

A business owner, in order to protect himself/herself from potential claims to pierce a corporate veil, can initiate steps to protect themselves.

First, a business owner should always keep personal and business assets separate from one another. This can be accomplished by using separate bank accounts and books for personal expenses and for the separate expenses of the business.

Secondly, always observe and follow corporate legal formalities such as holding the required number of meetings, keeping track of meeting minutes and maintaining a comprehensive stock ledger regarding the ownership of the corporation.

Third, usually an owner of a business will be an officer, agent or employee of the corporation. In business dealings on behalf of the corporation with third parties, business owners should always portray himself/herself as acting in the role of as an officer, agent or employee on behalf of the business as opposed to dealing with third parties on an individual basis. When the business enters into transactions or agreements with any outside party, that person must be aware and understand that he or she is transacting business with the corporation and not with the business owner personally. This can be accomplished when the business owner executes contracts, the business owner should list the name of the business and the business owner should sign in the capacity as an officer on behalf of the business.

In this difficult economic environment, people with claims against businesses are often more willing to make the extra effort to make a claim for piercing the corporation to obtain a judgment against the business owner's personal assets. If you have questions regarding this issue or would like assistance with conducting an audit of your corporation's records to assess your risk of the possibility of a plaintiff being able to pierce your corporate veil, please do not hesitate to contact us.

Dan A. Penning