- February 16, 2016
- Posted by: Seth Heyman
- Categories: Business Law, Startups
When The Corporate Veil is Not Enough
Business owners are naturally concerned with protecting their personal assets from liability for their company’s debts and other obligations. If managed properly, business entities such as corporations and LLCs will do just that, thanks to the “Corporate Veil,” which is a legal concept that separates the personality of a corporation from the personalities of its shareholders, and protects them from personal liability for the company’s debts and other obligations. However, to truly protect yourself, the corporate veil is simply not enough.
Although legal service companies such as LegalZoom may tell you otherwise, in real life corporate officers, directors, and shareholders are often named as defendants in lawsuits against their companies, regardless of the existence of the corporate veil.
There are three basic reasons why this happens:
1. Ignorance: Non-lawyers (and some lawyers) may be unaware of the corporate veil concept. This is often the case when non-lawyers sue in small claims court.
2. Pressure: Being personally named in a lawsuit is a stressful experience. Nothing ruins your evening more than having a process server show up at your door during dinnertime. Lawsuits are also public documents, and even if the case is completely without merit, it’s still out there for the world to see, and this can be embarrassing, especially if it includes a fraud claim. Unscrupulous attorneys often take advantage of this fact and ignore the corporate veil concept by naming individuals simply to bring that pressure to bear.
3. Failure to respect the corporate form: The owners of corporations and LLCs can legally be on the hook for the debts and obligations of their company if they fail to respect the corporate form. These is called “piercing the corporate veil,” and it can happen if owners commingle their funds with company funds, fail to maintain adequate corporate records, neglect required filings, or hold required meetings.
Regardless of whether there is a justifiable reason for being named personally, you’ll still have to deal with the time and expense of defending yourself. If you hire a lawyer to file a motion to dismiss you as an individual, it will wind up costing you hundreds if not thousands of dollars.
The best way to protect yourself from this scenario is through a general liability insurance policy. General liability insurance provides a wide range of coverage that can be crucial for a young business, such as protection against liability for bodily injury, property damage, and personal or advertising injury. Many insurers also offer to cover the costs of investigating and defending companies against legal claims, which is extremely useful if the legal claim is meritless.
It is important to note, however, that not all general liability policies cover individuals acting on the company’s behalf, so when shopping for insurance make certain that the policy offers that coverage.
You can also purchase Directors and Officers (D&O insurance), which pays for legal costs and losses incurred in connection with lawsuits brought against corporate officers and directors for alleged wrongful acts. Such coverage can extend to defence costs arising out of criminal and regulatory investigations as well.
The lesson here is clear. When online incorporation companies tell you that you can’t be personally sued if you’re incorporated, they aren’t telling you the whole truth. While a corporate structure should be set up to shield a startup’s owners from liability, a general liability policy can act as a second shield for the company’s founders.