A False Sense of Security in Business Registration.
Most business owners know registering their business entity with the North Carolina Secretary of State is a wise starting point when forming their company. Registering a legal entity such as a corporation or a limited liability company can have several benefits for the business owner.
It can give the business some legitimacy in the eyes of their consumers or clients. It can make the business appear “more official” to prospective customers. Registration can also provide tax benefits and perhaps most importantly, it can provide the owner protection from personal liability. This means the owner’s personal assets can be shielded from the business’s creditors and not reached in the event of a lawsuit involving the business. It is this hope of liability protection that makes entity formation most attractive. Unfortunately, after registering their business, many owners develop a false sense of security, believing their personal liability protection is absolute.
On the contrary, North Carolina courts sometimes disregard the business entity and hold the individual owners personally liable for the business debts according to a doctrine known as “piercing the corporate veil.” If the court applies this doctrine, it will treat the business entity as a mere “alter ego” of the individual owner or shareholder, and the owner’s home, personal bank accounts, or other personal assets can be at risk.
In considering whether to pierce the corporate veil and hold the owners personally responsible, North Carolina courts consider several factors. Some of those factors include:
Whether one person, or a small group of people, completely control the business operations, finances, and decisions so that the corporation does not have an identity independent from the owners.
Whether the company was adequately capitalized. In other words, courts consider whether the business has enough funds to stand on its own. A related factor is whether personal funds and company funds are comingled in the same bank account. Courts also consider whether personal funds are used to pay company expenses or conversely, whether company funds are used to directly pay the owner’s personal expenses.
Whether the company complied with the corporate formalities. Specifically, courts consider whether the company actually follows their shareholder or operating agreement and bylaws. Other considerations include whether the company holds required meetings, exercises voting rights in accordance with their agreement, and keeps appropriate records and documentation.
Many small businesses owners mistakenly believe forming an LLC or corporation is all they need to do for liability protection. However, prudent business owners take additional steps to ensure their business is operating as it should - as a true business entity, separate and distinct from the individual owners, and complying with appropriate business standards.
If you are a business owner and have questions or concerns about what your business can do to increase your liability protection, contact Hudson Legal Services for guidance.
