In most cases forming a corporation or an LLC will provide an individual with personal liability protection — but not always.
Stephen Hulst, attorney with Rhoades McKee, said there are instances when the “corporate veil may be pierced,” putting an individual’s assets at risk.
Hulst said there are three reasons a court may choose to set aside the liability protection offered to a corporation or LLC.
“Michigan courts will pierce the corporate veil if the corporate entity was a mere instrumentality of another entity or individual; the corporate entity was used to commit a fraud or wrong; and if the plaintiff suffered an unjust loss,” Hulst said.
He noted in making its determination the court will look at things such as whether the individual had been keeping separate bank accounts, separate books, or if the person had undercapitalized the company, for instance.
Hulst said part of the reason someone might choose to form an LLC for his or her business is the flexibility is greater than in choosing to become a corporation; however, he said that flexibility has its limits.
“You do have flexibility, but you can’t ignore documenting what you need to document or comingle money,” he said. “It’s important to follow formalities to retain the LLC.”
Hulst said instances where courts have allowed the corporate veil to be pierced are rare, but they do exist, and plaintiffs will often try to make the case for doing so.
“There was an opinion issued on Dec. 1 of this year, where the plaintiff sued an LLC and the individual member/owner of the LLC because they hadn’t been paid for certain work, and the owner/member was found liable for the debt,” he said. “One of the reasons was because that individual owner did not keep proper records and was informal in how she handled her business.”
He said due to those reasons the owner “is on the hook as opposed to just the LLC.”
Hulst recommends being very careful when operating a business and following all necessary formalities even if they aren’t specifically required, to ensure the LLC holds up in court.