Corporations and LLCs generally protect owners from incurring personal liability for the company’s lawsuits or debts — this protection is referred to as the “corporate veil.” However, in certain situations, a court may disregard this separation and “pierce the corporate veil” to allow the individual owners to incur liability for corporate misconduct. Less commonly, a court may allow for reverse piercing of the corporate veil, which permits creditors to access business assets to pay for an owner’s obligations.
What is Reverse Piercing of the Corporate Veil?
Most business owners know that the corporate veil can be “pierced” if they use the business entity to perpetuate fraud, fail to follow corporate formalities, or commingle personal and company funds. When the corporate veil is pierced, a creditor is permitted to seize the personal assets of an owner to satisfy a corporate debt. However, it’s essential to be aware that this legal doctrine can also work in the opposite direction.
Reverse piercing of the corporate veil is an equitable remedy that allows a creditor to seize business assets to satisfy the debts or liabilities of an individual owner. In other words, this doctrine allows a business to be held responsible for an owner’s debts. A court may permit reverse piecing of the corporate veil under the following circumstances:
- The corporation is the alter-ego of its shareholders
- Corporate formalities are disregarded
- The owner uses the corporate entity to perpetuate fraud or wrongdoing
- The owner uses the company to avoid personal obligations
- The corporation is under the complete control of the owners
Notably, reverse veil piercing is an extraordinary remedy typically only granted in limited situations to prevent abuse of the corporate form.
How Can Reverse Piercing of the Corporate Veil Be Avoided?
There are several things business owners can do to avoid reverse piercing of the corporate veil. Best practices can include:
- Maintaining separate business and personal bank accounts — While courts often look for signs that corporate and personal assets have been commingled, it’s crucial to maintain separate accounts. Personal expenses should not be paid with business funds and vice versa.
- Following corporate formalities — When a business fails to follow corporate formalities, courts are more willing to disregard its separate existence. It’s essential to hold annual meetings with recorded minutes, and maintain up-to-date bylaws, operating agreements, and other governing documents.
- Keeping accurate accounting records — Documenting all transactions and keeping accurate accounting records can help keep a company’s veil intact.
- Avoiding using the company as a personal asset shield — Reverse veil piercing is commonly used when personal assets are transferred into a business entity to avoid paying personal debts.
- Ensuring the business has a legitimate purpose — To avoid reverse veil piercing, a company should have a legitimate business purpose beyond protecting personal wealth. Ensure adequate capitalization, keep the business operational, maintain proper documentation, and conduct business transparently.
A knowledgeable business attorney can assist with structuring your entity to minimize the risk of traditional and reverse veil piercing. They can also work with you to ensure you follow corporate formalities and maintain separation of your personal and business finances.
Contact an Experienced New York Business Attorney
If you are facing a matter related to traditional or reverse veil piercing, it’s vital to have a skillful business attorney by your side to protect your interests. At Barnes & Barnes, P.C., we offer high-quality legal services and comprehensive counsel for a wide range of commercial matters across Long Island. Contact us at (516) 673-0674 to schedule a consultation.
