Piercing the Veil

Legal matters, business strategy and life perspectives from the mind of a non-attorney.

Calling all business owners!

No personal stories this week. Let’s get right to work.

As a business owner, you have business assets and you also have personal assets. Duh! Duh! Duh!

I make that obvious statement for a reason, though. As I get into the “meat and potatoes” of this blog, I don’t want the IDEAS to distract from the BOTTOM LINE: This blog is only relevant because business owners want to maintain that distinction – that line – between business assets and personal assets.

How does someone obtain that line of distinction?

Here’s what you do: Grab a blank piece of paper out of your printer and begin thinking of all the things that your business owns – or will own once you start it. Now, organize those things into a list (on the left side of the page) from most expensive to least expensive. Then, on the right side of the page do the same for your personal assets. Now – this part is critical – find a Sharpie Fine Point Permanent Marker; and, with a ruler, draw a perfectly straight line in between your two lists.

Viola! One distinct line between your business assets and your personal assets.

If you really want to maintain distinction between your business assets and personal assets, of course you’ll have to set up a LEGAL entity (probably an LLC or Corporation).

Ok Kelton, you’re soooo funny. But why is it important to have that distinction between business assets and personal assets?

Boring answer: To protect your personal assets if your business should ever get sued.

Fun answer: Suppose Joe Schmoe is a really wealthy guy. He made his millions the old fashioned way: Struck it big on the lotto. Now he’s bored, so he decides to buy a very small mom ‘n pop bakery (Schmoe Sweets, LLC.), because he loves to bake desserts. He has no employees, it’s just him. One day, he mops the floor in front of the display case, and as he’s going to grab the “Caution Wet Floor” sign, a young boy slips and severely injures himself. The young boy’s parents sue Joe Schmoe. What happens next?

  1. The attorney representing the little boy is only able to come after the small amount of assets that the business owns.
  2. The attorney representing the little boy comes after the assets of the business AND a huge chunk of Joe’s lottery winnings.

*The answer is “a” if Schmoe Sweets, LLC. is set up as a perfectly legitimate legal entity, and Joe follows all the rules.

*The answer is “b” if Joe Schmoe did something wrong when he set up the entity, or if he is doing something wrong now!

Guess what? It is literally in the attorney’s job description to figure out if Joe did anything wrong. 

If the attorney finds something, they can PIERCE THE VEIL, and grab at Joe Schmoe’s personal assets (lottery winnings) – in addition to the “business” assets.

So… Now you know why business owners set up LLC’s and Corporations. You also know what Piercing the Veil means! If that’s all you came here for, class is dismissed.

If you want to know what those “things” are that attorneys use to Pierce the Veil, let’s KEEP ‘ER MOVIN.

Young boy slips in Joe’s bakery and severely injures himself. The boy’s attorney will ask the following questions to try and Pierce the Veil:

  1. Is the entity operating as a legitimate business?
  • FAIL: Joe bought the business and realized that he didn’t really know how to run a business – he just likes baking – so he only opens up the bakery on Sundays for members of his church to enjoy free treats and socialize before/after church.
  1. Is there commingling of assets?
  • FAIL: Joe took out a company credit card when he started Schmoe Sweets, LLC. The card earns him 4% cashback on all purchases, so he uses it for EVERYTHING, including personal expenses like dining out, groceries, and home repairs.
  1. Is there adequate record-keeping?
  • FAIL: Joe was having a lot of trouble finding a good assistant to help him run the business, and in the span of one year he ran through 6 different assistants before finding one that stuck with him. Joe didn’t keep ANY records of the individuals he hired/fired.
  1. Is the company undercapitalized, or was it undercapitalized at formation?
  • FAIL: Joe set up a bank account in the company’s name, but normally maintains the minimum balance of $100. Bank records show very little activity in the account since it was opened. Accounting records indicate that the business costs $2,000 per month to operate.
  1. Is the company a “shell” of the business owners?
  • FAIL: Joe’s business cards, email signature, stationary, menus, and website all say: “Treats by Joe Schmoe”. There is minimal effort to identify his entity: Schmoe Sweets, LLC.
  1. Does the company disregard Bylaws / Operating Agreement?
  • FAIL: Joe’s Operating Agreement states that all corporate records are to be held at his principal place of business. Joe, instead, keeps his corporate records at his cabin up north, for safe-keeping.
  1. Are assets used for non-company purposes?
  • FAIL: Schmoe Sweets, LLC. bought a “company jet”, but Joe uses the jet only for personal vacation.
  1. Is the business being used to defraud creditors or avoid legitimate claims of creditors?
  • FAIL: Joe knows he is about to be sued. He shuts down Schmoe Sweets, LLC and transfers all its assets to a new LLC: Joe Mama’s Bakery, LLC.

Understand that these are mere examples of situations that could lend a creditor to Pierce the Veil. In all judgements, it will be the task of the judge/jury to weigh the balance of the facts in question. This means that in most cases, business owners will need to fail more than one test to be exposed.

Finally, it is important to remember that fraudulent acts on the part of a business owner will automatically bypass the corporate structure.

Special thanks to Attorney Chris Klingman for his help in authoring this blog.

Chris specializes in litigation for the Epiphany team, and has represented both sides of “Joe Schmoe’s” scenario on numerous occasions.

It’s worth mentioning that when I asked Chris if he would help me to understand something for a blog I was writing, his immediate response was, “Yes. Absolutely. In fact, I have some time right now. Let’s do it.” It was the perfect representation of the culture that has been built here at Epiphany: A passion for going above and beyond to help others.

Allow me to reiterate some context, so that you can appreciate Chris’ attitude as much as I do:

  1. Attorneys don’t “have time”. Period. Chris had time for me.
  2. I AM NOT Chris’ equal in any way with respect to career experience, business acumen, or legal knowledge. In many-if-not-most firms, non-attorneys are treated like inferiors. Chris respected me.
  3. My most popular blog took a direct aim on the business model that Chris operates in. Chris didn’t hold it against me.

I’ve gotten used to having my opinions, thoughts, and ideas respected around here. But I don’t ever take it for granted. I know it’s not like this everywhere.

There is no doubt in my mind that Epiphany Law is the firm that you want to trust with your business’ legal needs. Whether you’re working with Chris or any of our other attorneys/staff, I am confident that your experience will be as positive as the one I have here every day. It’s just in our DNA.

Thanks to all for the continued support! If you have questions, comments, or topic suggestions for us, please direct those to:[email protected]

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