This is the first of a series of occasional blog entries dedicated to explaining how Indiana courts deal with the "corporate veil" and "veil piercing" and what small business owners can do to protect themselves from being personally liable for the debts and obligations of the business. "Corporate veil" is a phrase used to describe the liability shield between the owner of a company and the company itself, and, as the name implies, it originated in the context of corporations. Without the corporate veil, corporations could not raise capital by selling stock to investors, and modern stock exchanges could not exist. Imagine that you buy $10,000 worth of a corporation's stock through an online stock broker, maybe the one with those talking baby commercials, hoping to collect some small dividends for a few years, then sell the shares at a nice profit. Now imagine that one day an envelope appears in your mailbox, but instead of a quarterly dividend check, it contains a letter from the company's creditors saying that the company does not have enough money to pay its bills and that, for your convenience,they have enclosed an envelope that you may use to mail in payment of your share of the corporation's debt, which comes to $75,633. And 27 cents. No personal checks, and the post office will not deliver mail without a stamp. I suspect that would be the last stock you'd ever buy. The reason that doesn't happen is the corporate veil. Even if a corporation's stock becomes worthless, the shareholder's loss is limited to the money he or she invested in the stock. The shareholder's other assets — the house, the car, the 401(k), the baseball card collection, and the family dog — are safe from the corporation's creditors. And that's true not only for the shareholders of large, publicly traded corporations; it's also true for the owners of the smallest incorporated businesses. Furthermore, as a previous blog entry explained, the same type of corporate veil prevents the creditors of a limited liability company from reaching the assets of the LLC's members. At least, that's the way it works most of the time. However, sometimes, in certain circumstances, a court may allow the creditors of the LLC or corporation to reach through the corporate veil and to collect directly from the business owners. That's called "piercing the corporate veil," and one time it can happen is when the owner has used the company to perpetrate fraud. A future entry will discuss in more detail the circumstances that can lead to veil piercing. But before we get there, business owners need to remember one other limitation of the corporate veil — it does not protect them from their own liability. That commonly arises in one of two different ways. First, imagine of a group of engineers who start their own engineering firm and organize it as a limited liability company. If one of the owner-engineers negligently makes a mistake on a design project, that particular owner-engineer can be held liable — not because he or she is an owner of the LLC, but because he or she is the engineer who made the mistake. In addtion, the LLC will also be liable (at least in most cases), but the personal assets of the other owner-engineers will be protected by the corporate veil. (Hopefully, the owners will have heeded my earlier advice to get a good insurance broker, and the LLC will have an errors-and-omissions policy to cover the liabilty of both the LLC and the negligent engineer.) The second common way that a member of a limited liability company becomes liable for the obligations of the LLC is when the member contractually assumes the obligation. For example, banks and other lenders often will not extend a loan to a small LLC unless the members sign a personal guaranty that obligates them to repay the money if the LLC doesn't. In those situations, the corporate veil does not prevent the lender from reaching the personal assets of a member-guarantor. Watch for my next entry on this topic to learn about what you can do to protect your company from having its corporate veil pierced. (Sounds painful, doesn't it?)
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