This article has been updated since originally published in CreditToday with new input from attorneys and other credit professionals. We received numerous comments via CreditToday, InsideARM and LinkedIn that has been incorporated into this revised edition.
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.
Since this post was originally published, Jay Winston provide this link to his article that describes over a dozen factors that will affect your ability to pierce the corporate veil.