When Is An Individual Liable For An Entity’s Debts? Piercing The Corporate Veil
People often do business through corporate entities such as corporations, LLCs, and limited partnerships in part in order to limit risk of personal liability. Generally speaking, corporate shareholders, members of LLCs, and limited partners have no liability for the entity’s debts. The entity acts as a kind of “shield” or “veil,” protecting the investors behind the scenes by limiting their losses to their investment in the entity. The American legal tradition has seen fit to permit this system, even though it often times results in the entity’s creditors or tort victims suffering losses, because we as a society have decided to encourage investors to take risks to foster investment and innovation, and to make gains for society at large in the long run. The law treats the corporate entity as a “person” who legally exists separate and apart from its investors, and as such, the entity can sue and be sued. Many people mistakenly imagine that this shield from personal liability is absolute (i.e., that as long as you conduct your business as a corporate entity, you never run the risk of personal liability), but that is not the case. The law recognizes exceptions to the general rule, and there are some instances where a creditor may assert or collect a debt against an individual investor (i.e., shareholder, member, or limited partner)- this is often referred to in legal circles as “piercing the corporate veil,” or “disregarding the corporate entity.”
In broad terms, Washington courts allow creditors to pursue individual liability of an insolvent entity’s investors “when the corporation has been intentionally used to violate or evade a duty owed to another.” The general test takes two factors into account: (1) the corporate form must be intentionally used to violate or evade a duty; and (2) disregard must be necessary and required to prevent unjustified loss to the injured party. “Abuse of the corporate form” typically involves fraud, misrepresentation, or manipulation of the corporation to the shareholder’s benefit at the expense of creditors. To meet the second factor, the injured party must show that the wrongful corporate activities actually caused them harm, and that intentional misconduct was the cause of the harm that is avoided by disregard of the corporate form. The mere fact that an entity’s assets are insufficient to discharge its obligations is not enough to pierce the corporate veil. However, if an entity is made insolvent because its owner(s) drained its assets while knowing, or having reason to know, of its likely insolvency, there may be personal liability. Entity owners should be careful to keep their personal assets separate from those of the entity; co-mingling assets may support a finding that the entity was the mere alter ego of the individual, that there was no real distinction between the two, and that a court should therefore disregard the corporate form to hold the individual personally liable.
The important lesson for business owners is to not take for granted that operating through an entity will always shield you from personal liability.
The lawyers at Beresford Booth have a wealth of experience in forming businesses entities, and in litigating in the context of potential liability of businesses and their owners. We would be happy to assist you in building your business, mitigating your personal liability, or in developing the best strategy when a business dispute arises.
To learn more about When Is An Individual Liable For An Entity’s Debts? Piercing The Corporate Veil, please contact Beresford Booth at info@beresfordlaw.com or by phone at (425) 776-4100.
