Firm News

Piercing the Corporate Veil - The Importance of Business Entity Choice for Small Businesses

Entrepreneur reviewing business entity formation documents.

According to the United States Chamber of Commerce, American companies face an ever-increasing number of lawsuits each year. For those who own businesses in the United States, it is no surprise that the average amount each business spends annually in fighting lawsuits is over $1 million. These figures may serve as an important warning for those planning to create businesses in the near future. Many new entrepreneurs assume that by forming a corporation, they can shield their personal assets in the event of lawsuits; however, this protection has limits, which vary depending on business entity choice. Identifying the optimal business entity choice to maximize efficiency while managing risk is therefore paramount to any small business. To learn more about corporate litigation and the effects of business entity choice, speak with a business litigation attorney with Schwab & Gasparini. Call (315) 422-1333 in Syracuse, (518) 591-4664 in Albany, or (914) 304-4353 in White Plains or Hudson Valley today to get started.

What Does “Piercing the Corporate Veil” Mean?

The United States Chamber of Commerce suggests establishing a business as either a limited liability corporation (LLC) or a corporation, emphasizing that this approach "reduces the risk to your personal assets."In other words, a business owner of an LLC or a C-Corp is less likely to lose their house or their car because their company lost a lawsuit than might be true for the owner of a commercial enterprise with a different business structure.

As the Chamber of Commerce explains, a private individual operating a C-Corp or LLC is unlikely to be held personally responsible for their company’s legal liabilities under the majority of circumstances. The Chamber of Commerce’s exact phrasing, “under most circumstances,” may be somewhat worrying to business owners, as it suggests that the corporate structure may not be as impermeable as it first appears. As a business attorney with Schwab & Gasparini could tell you, it is indeed possible to break through this barrier of corporate protection – and this is what the phrase “piercing the corporate veil” refers to.

When Might a Lawsuit Pierce the Corporate Veil?

A number of practices and circumstances can lead to piercing the corporate veil. Business owners might lose the protection of their corporate veil in many situations, including:

The Failure To Pay Debts May Expose Personal Liability

Courts may pierce the corporate veil if business owners are unable to pay their debts. This is, unfortunately, a common situation with small businesses, especially those with a small operating budget and only one or two owners.

Fraud May Pierce the Corporate Veil

Another common situation that pierces the corporate veil is an allegation of fraud. If the company is found to have committed some scam or fraud, the business owners may become personally liable. If the investigation finds that the corporate structure was created specifically to facilitate fraud, then courts will frequently pierce the veil.

Personal Guarantees or Promises Can Pierce the Veil

Although business owners may protect their personal assets with corporate structures, they may take actions within these corporations that reflect serious wrongdoing on a personal level. One example comes in the form of “off-the-record” promises – perhaps made in order to secure lucrative contracts. These promises or guarantees may be completely undocumented in the corporate minute books, and the absence of documentation coupled with evidence of business activity may allow courts to pierce the corporate veil.

Commingled Funds May Lead to a Pierced Veil

New York law specifically mentions commingled funds as a valid reason to pierce the corporate veil. Commingled funds represent a mixture of both personal and company assets – something that is never supposed to happen under the same United States regulations that provide for the formation of business entities. Because tax filing, accounting, and business structure are all closely related, New York courts may also pierce the veil if a company fails to file independent tax returns.

What Does It Mean To Choose a Business Entity?

A company’s business entity choice is important, as this determines its legal structure and tax obligations. According to New York’s Department of State, business entity choice is also one of the first steps on the road to doing business in the Empire State. Entrepreneurs have various business entity options to consider, such as sole proprietorships, partnerships, and cooperatives. However, only a select few provide protection against personal liability:

C Corporations (C-Corps)
S Corporations (S-Corps)
Limited Liability Companies (LLCs)

The Key Differences Between LLCs, C-Corps, and S-Corps

LLCs represent the simplest choice. Entrepreneurs who choose this option experience few administrative requirements and have the opportunity to take advantage of pass-through taxation while still protecting their personal assets. Technically speaking, an S-Corp is a tax designation rather than a business entity choice, but the close relationship between tax considerations and entity choice means that entrepreneurs wanting to file taxes as S-Corps will likely want to take that preference into account as they set up their legal business entity. Suitable for small-to-medium businesses, S-Corps offer some tax advantages but with greater complexity, stricter rules, and more requirements under the Internal Revenue Service than LLCs. Finally, C-Corps are suitable for major, publicly traded corporations and generally offer tax advantages only if the business reaches a certain scale. However, these structures have one thing in common: They provide comparable levels of personal liability protection.

Which Business Entity Choice Is Best for Personal Liability Protection?

A C-Corp provides limited liability not only for the shareholders but also for the company’s employees, directors, and officers. In other words, this business entity chooses to distribute limited liability protection across the entire organization. An LLC, however, may only provide limited liability protection for the owners. Generally speaking, C-Corps and LLCs both represent viable choices for those who wish to protect their personal assets. Regardless of which option an entrepreneur chooses, these choices provide greater protection than partnerships, sole proprietorships, and co-ops. Speak with a New York business litigation attorney to discuss additional layers of personal liability protection.

The ease with which courts pierce corporate veils in New York depends on many factors, including those that have nothing to do with the business entity choice. An independent trucker who experiences a lawsuit after hitting a motorist might have an LLC with just $1 in its bank account. The injured motorist may then attempt to sue the LLC, and the corporate veil may be pierced because companies are required to have enough capital to cover their losses. In addition, the court might view this company as a rather transparent “alter ego” rather than a legitimately separate entity. While these smaller, lower-earning companies are more commonly associated with LLCs, the same situation could theoretically unfold with a C-Corp instead.

Speak With a New York Business Litigation Attorney Today

Each New York business is unique, and the most appropriate business entity choice for each business depends on their specific circumstances. While internet research can provide some guidance on how the corporate veil may be pierced, a New York business litigation attorney can provide more targeted advice. Call (315) 422-1333 in Syracuse, (518) 591-4664 in Albany, or (914) 304-4353 in White Plains or Hudson Valley to discuss your situation with an experienced attorney at Schwab & Gasparini today.

Tue Dec 19 2023, 12:00am