While the concept of a “corporate veil” may sound like silly legal jargon to many, this important concept is not one to be dismissed. With your personal liability on the line, appropriately structuring your business enterprise is an important (yet often overlooked) consideration in protecting your business and yourself. It also comes with benefits, as it affords you the opportunity to maximize flexibility in your business sales.
Our experienced downstream energy and multi-site retail attorneys have compiled a list of commonly asked questions about organizational structuring, the corporate veil, and actionable steps you can take to better situate yourself and your organization to protect against future liability:
1. What is a corporate veil?
In a legal context, the “corporate veil” refers to certain legal protections that act to shield an individual business owner (or group of shareholders/owners) from the liabilities and obligations of their business entity – whether that be a limited liability company (“LLC”), corporation, and certain other legal entities. When functioning appropriately, this “veil” prevents the obligations and liabilities of the entity from flowing through to the owners. Similarly, a “veil” can function to shield the liabilities and obligations of one business entity within a more complex overall enterprise structure from the liabilities and obligations of another entity within that structure.
This separation between individuals and a business entity or between business entities that are part of a larger enterprise structure, is at risk of being “pierced” when a court decides to disregard the otherwise expected separation, thereby opening up the owners to personal liability for the obligations, debts, etc. of the business, or exposing the assets and operations of one entity to the liabilities and obligations of another.
2. What steps are needed to establish separate legal entities?
Many of our clients in the fuel business operate as part of a larger, integrated group of distinct businesses.
For example: The overall group of companies may include a fuel distribution business, a retail gas and convenience store business, a trucking business (with individual trucks/drivers), and a home heating oil or propane business.
Often, these clients find it beneficial to organize each business within its own legal entity, with the group of businesses typically connected through common ownership and control and several key contractual arrangements. In operations that are structured with multiple entities under a corporate umbrella or similar control structure, a related concern is protecting each entity in the structure from the liabilities and risks of each other entity in the structure.
One of the most common arrangements is to establish a holding company, owned by the owners of the business enterprise. This can be set up as a corporation, limited liability company or partnership, depending on the particular ownership, tax and other considerations. Beneath the holding company, each business unit is organized in a separate legal entity (typically an LLC or a corporation in most cases), and each of these entities would be wholly owned by the holding company. In some cases, tax and other corporate motivations can result in the organizational structure having multiple levels, but there is most commonly a single entity at the top of the structure. One important objective of a structure like this is to isolate the potential risks and liabilities of each business to that business unit itself, rather than exposing the entire enterprise to the risks of one particular business operation.
For example: An incident that occurs in the trucking business might expose the company to material liability (e.g. a product spill, an accident causing death, etc.), but a properly established and maintained organizational structure could keep the liability and exposure from that incident with the trucking company, while sheltering the retail business, the fuel distribution business and others in the structure which are owned by separate entities.
3. If I don’t structure my business this way, what’s the risk?
While plenty of organizations, big and small, choose to operate this way – we’ve seen marketers with entire truck fleets held by their operating company, which also holds all corporately-owned convenience stores and other real estate assets – we also see significant benefits to a more compartmentalized structure.
In addition to the primary risk of exposing the assets of the entire business enterprise or the underlying owners/shareholders (including your personal bank accounts) to liabilities existing within one of the businesses, an individual shareholder or officer may be held personally liable for their own negligent conduct (which in extreme cases can involve potential criminal liability). Courts in various jurisdictions have held owners/officers liable for their actions – determining, based on the applicable facts, that it was appropriate to look beyond the corporate entity to the individual actor.
Insurance is another primary concern. If assets of the entire business enterprise are held by a single operating company, insurance obtained by that entity may be insufficient to cover the scope of prospective liabilities or potential claims for each segment of the business. In such a case, denied or underinsured claims resulting in judgments will be collected from the assets of the overarching business, not just the individual business entity at issue, potentially bankrupting a multi-channel organization, unnecessarily.
Another “risk” is less flexibility or added complications in selling off one or more distinct businesses within the enterprise. A sale transaction involving one business unit or division that is held in a separate entity is generally smoother, cleaner and less expensive than one that is held within a single company that also includes other business divisions that are not being sold.
4. If I do separate my business(es), how easy or likely is it for the court to pierce the corporate veil, and make a claim on other company assets, or shareholders’ personal assets?
Generally-speaking, there is no “hard and fast” rule for determining whether any particular structure will hold up in court. Attempts to pierce the corporate veil often turn on the facts and circumstances of each particular case, and the specific tests used to determine whether the veil will be pierced depend on the applicable state law. Given this state and factual variance, the law generally favors the “limitation of liability” feature of corporations, limited liability companies and similar legal entities. This means that, as a general rule, liabilities and obligations of such entities remain with the entity, and do not extend to the owners, officers and directors of that entity.
That said, there are operational steps an organization can take to reinforce the separate nature of an owner/business or between various businesses up and down the chain. When helping clients establish a structure and manage operations in a way designed to maintain the liability shield described above, there are several factors that we take into consideration. Some of these factors fall into a general category of “corporate formalities,” such as the following:
- Holding out each entity to the public as a separate, distinct entity (e.g., using separate phone numbers and email addresses, separate logos; using the appropriate business names on your invoices, etc.)
- Properly capitalizing each entity for the specific business being conducted by that entity (e.g., providing each entity with sufficient capital to carry out normal business functions and meet reasonably anticipated obligations)
- Ensuring that each entity in the structure has a board of directors or governors, each board elects officers or managers, and annual or other periodic board meetings are scheduled to conduct the business of each entity (including the taking of meeting minutes, etc.);
- Documenting business dealings between entities through written agreements
- Maintaining separate bank accounts, books, and records, and avoiding any commingling of personal and business assets
- Ensuring that any “sharing” of funds between entities is carefully documented and described (e.g., reflecting intercompany loans on the books of each entity involved)
- Ensuring that loans to and from shareholders are adequately documented (use of business assets or corporate funds for personal purposes is a big “red flag”)
The general principle is that the “separateness” of each entity should be reflected in the daily operations and in the corporate books and records for each entity in the structure.
5. Separation is expensive – is there anything I can do?
Although maintaining “separateness” is of critical importance, there are practical business operational concerns that can be addressed by contractual arrangements. For example, it could be unwieldy and expensive for each entity in this type of structure to handle its own administrative matters, including functions such as accounting, insurance and human resources. In these situations, we often help our clients create administrative services or similar agreements, so that these types of functions can be performed by one entity (often at the holding company level) for all entities in the structure. So long as these agreements apportion costs and expenses among the entities on a reasonable basis, they can allow for greater efficiency, while not undermining the goal of shielding the entities from their respective liabilities. In addition to these agreements, we also recommend that entities within the structure that are doing business with one another (e.g., the fuel distribution company supplying the gas and c-store company) do so under written agreements that are on customary industry terms and conditions.
There is no guarantee that any particular organizational structure will survive any and all attempts to pierce the corporate veil. However, establishing and maintaining an entity structure that respects the separateness of the entities in the structure, and putting in place agreements among the companies for any shared services or inter-company transactions, can provide strong arguments that the liability of any one or more entities in the structure should stay with those entities.
We always recommend that companies seek sound legal, tax, and accounting advice in creating their organizational structures, as each situation can present unique goals and issues. If you’d like to learn more about the legal implications of piercing the corporate veil or about structuring your business, visit us at www.winthrop.com.
