When starting a business, one of the most important decisions a person must make is which legal structure to choose. There are many choices, and each type has various benefits and downsides. For example, while a sole proprietorship is easy to form and is subject to pass-through taxation, the owner can be held personally liable for business debts and any legal judgments against the business. A corporation, on the other hand, provides protection for the owners and high-ranking members of the corporation, but is complex to form and maintain and is subject to double taxation.

Even though corporations generally provide a shield from liability, there are certain instances when officers or directors can be held liable for corporate actions. The general circumstance when this can occur is referred to as "piercing the corporate veil." This article provides a brief summary of what it means to pierce the corporate veil and instances when officers or directors may be held liable.

What Does It Mean to Pierce the Corporate Veil?

People tend to pick the corporation as a legal structure specifically to be able to protect themselves from liability for the business's actions and debts. But, it's important to realize that this liability is still a limited protection. There are certain instances when a court will "pierce the corporate veil" and hold officers, directors, and sometimes even shareholders liable. Generally, a court will do this if it doesn't believe that the corporation was formed for legitimate purposes, but rather to simply provide protection for the owners. Below you can find some specific examples of times when a court may pierce the corporate veil.

When Officers or Directors May Be Liable

Sometimes, courts will allow plaintiffs to receive compensation from corporate officers or directors for damages rather than limiting recovery to corporate resources. This procedure avoids the usual corporate immunity for organizational wrongdoing, and may be imposed in a variety of situations:

• If a business is indistinguishable from its owners in practical terms, courts will not allow owners to benefit from limited liability. For example, Jessica's Jewels, Inc. and its owner, Jessica, share the same bank account, and Jessica signs business contracts in her own name. In this scenario, Jessica may be liable for breaching a business contract because she and her company are legally indistinct.
• If a corporation is formed for fraudulent purposes, courts will allow recourse to the owners.
• If a business fails to follow corporate formalities in areas such as record-keeping and decision-making procedures, a court may impose liability on the individuals controlling the business.

The potential for personal liability encourages businesses to observe legal requirements and to avoid damage to third parties. Since it is possible to hold directors or officers personally liable in certain instances, it may be a good idea to purchase directors' and officers' insurance.

Getting Legal Help

Forming a corporation can be complex and there are various requirements to maintain corporate status. As you can see from this article, failure to comply with all of the requirements can result in directors or officers being held personally liable for corporate actions. If you have questions about the concept of piercing the corporate veil, or would like help setting up a corporation, you may want to contact a local business and commercial attorney.

For more information and resources related to this topic, you can visit FindLaw's section on Incorporation and Legal Structures.