Three ways your corporation might not protect you

Dear Alex:

I am the owner of a small interior decorating business with three employees.

When I began business in 2010 I formed a corporation to protect myself.

Recently, one of my employees accidentally bumped a client’s house with our work truck and caused damage to the building. The client has threatened to sue me personally.

Can they do that?

One of the first calls you should make when there is an incident of loss and damage should be to your insurance carrier. If you have sufficient insurance, this type of matter is most commonly resolved through the insurance carrier.

However, if you have gaps in coverage or have reached your policy limits, you or your business will be on the hook. If you accept that there was fault and there will be money damages in your case, your business will be exposed to that liability.

The question of whether your personal assets may also be exposed to these damages depends on the facts of the case and how you have operated your company in the past.

Often, people believe that once they form a limited-liability entity like a corporation, they do not need to take further steps to protect themselves personally from the business’s liabilities.

That assumption is often incorrect, and every business owner operating through a corporation should be aware that a business’s limited liability protection does have limitations.

When those limits are reached, a court can hold the shareholders (the owners) personally liable for business debts, which is known as “piercing the veil” of limited liability.

Here are three common ways limited liability protection of a corporation can be pierced:

Commingling of assets

“Commingling” occurs when the owner combines his business assets with his personal assets. This can happen in many ways, such as if the business owner keeps his business income in the same bank account as his personal bank account, or owner pays personal debts with corporate funds.

Not observing corporate formalities

A corporation must appoint officers, hold annual board and shareholder meetings, keep annual minutes, and file annual documents with the California Secretary of State. Failing to do so could disrupt the liability protection of the company.

Undercapitalization

Undercapitalization essentially means that the business does not have enough money or assets to cover its reasonably foreseeable liabilities. The adequacy of a corporation’s capital is determined on a case-by-case basis and depends on the type of business being conducted.

Fortunately, by keeping business assets separate from personal assets, properly documenting adherence to corporate formalities, as well as adequately capitalizing the business, a prudent owner can avoid these pitfalls and maintain the limited liability protection of their personal assets that a corporation offers.

Alex Myers is a business attorney with Myers & Associates in Napa. Reach him at alex@myers-associates.com or 707-257-1185. The information provided in this column is not intended as legal advice, nor does it create an attorney-client relationship. The information is not a comprehensive analysis of the law — if you need legal advice, contact an attorney.

This column originally ran in the Napa Valley Register on October 11th, 2016. You can read it on the Register's website here: "Three ways you corporation might not protect you"