One of the very useful aspects of the limited liability act and the Michigan business corporations act is that it provides protection for a business owner’s personal assets if the company defaults on its loans or otherwise has a judgment against it. This is not a complete protection, and if a business owner fails to adhere to the law, and action called piercing the corporate veil can occur. This normally occurs when a business owner commits fraud, commits an intentional tort, or in other ways attempts to defraud or hurts another individual.
What do I do to protect myself?
One of the biggest issues I see on a regular basis is that individuals sign in their own name and not on behalf of the company. I suspect so many people get this element of corporate law wrong because they are very used to simply signing their own name on checks to letters and other contracts. However, simply signing a letter or signing a contract in one’s personal life is not the same as signing a letter or a contract as a business owner.
Your signature block must always contain the name of the company, your name, and your title”. Your title can be anything from presidents, member, or “authorized agent.” I prefer using the term authorized agent when signing documents for Corporation. It provides some protection as to whether or not the individual signing is simply an officer of the company or in owner. This can be helpful if you are trying to insulate the ownership of the company from various and sundry individuals.
I represent a private equity firm that prefers to keep the names of its owners quiet. This is because they do not want their friends or family coming to them attempting to garner favor and therefore loans at reasonable rates from an entity which they don’t know exists or in the alternative who they don’t know they are so closely related to. Therefore, utilizing terms such as authorized agent allows for those sorts of protections. Further, the utilization of authorized agent oftentimes will allow the company’s attorney to Beale to sign on its behalf as long as there is some specific statement and review and approval of those documents from the owners of the company. However, I will note that this could potentially open the attorney to some liability. However if the relationship between the attorney and the client is good, and the attorney takes the steps listed above to ensure that the client approves of the documentation signing on the company’s behalf offers little possibility for malpractice.
Talking about authorized agents lends us to apparent authority as well. Apparent authority is the authority that the employees of an LLC on Corporation appear to have two individuals outside of that entity. Oftentimes courts will rule as enforceable contracts which are entered into by individuals who have no specific right to enter into a contract but the other parties to the contract relied in good faith on the demonstrations of the employee of the LLC or corporation that they have the right to enter into the contract. This is not to say that the company is without recourse against the employee who so overstepped their bounds. However, it does drive home the fact that when hiring employees, especially employees who appear to have the ability to sign documents, you must pick very trustworthy and truthful individuals. Otherwise, you could potentially expose yourself to serious liability and contracts which you would never have entered into otherwise.
Piercing the corporate veil
In general, the corporate veil is pierced upon one of two bad acts quote that (one) the attempt to defraud another person in the corporate form and (two) the co-mingling of funds.
Fraud normally occurs, and the corporate veil is pierced, when an individual starts a company racks up a large number of debts and then closes the company without making any allowance for those debts. I recall the case where one of those pop-up cell phone store companies rented a certain piece of commercial real estate from one of my clients. The cell phone store existed for may be six months out of the 12 month lease and then closed up shop and the owners of the company dissolved of the company without making any allowance for the outstanding lease. We were able to locate the parties to the lease and the owners of the company. We successfully sued those individuals because they violated the Michigan business corporations act and failed to address the outstanding debts of the company.
The moral of that story is you cannot simply dissolve a company without making proper overtures to all potential creditors of the company. In fact both the LLC act and the Michigan business corporations act provide a specific carve out to protections under the corporate veil if you’re attempting to dissolve your company without addressing the outstanding debts of the company. This is why we won her case. The LLC act in Michigan business Corporation act do not require that you pay off the debts in full, but only that you make a good-faith effort to identify the creditors and attempt to settle any outstanding debt out of the assets of the LLC or the Corporation. This can get a little Hinchey and small businesses. Small businesses normally are required to sign guarantees and an individual is on the hook for whatever the LLC or the Corporation does not pay. This can mean that even if the corporation or the LLC can successfully settle the debt as to the LLC of the Corporation the individual who is the guarantor may still be on the hook for the rest. It is very important to determine whether or not your settlement with your creditors will protect the individual guarantors to any contract.
Co-mingling of funds
The other issue I often see in dealing with small companies is the owners do not maintain a separate bank account for the company. Instead all the money flows through the bank accounts of the owner. The second the money of the corporation or company and the money of the owner merges into a single account a legal phenomenon known as co-mingling of funds takes place. Once the funds are co-mingled, you lose the protection of the corporate form and the corporate veil. In essence the thing that took me six months to obtain in a landlord-tenant case, piercing the corporate veil, happens automatically due to either sloppy record-keeping or inappropriate advice to the business owner.
This is why it is essential that any new corporation or company open bank accounts, get checks made, and ensure that any payments made to the company are made directly to the company. If an owner decides to lend money to the company, that lending of money should be memorialized in a note, and transferred into the company’s bank account then bills or capital assets can be purchased with drafts drawn from the company’s account. This is the proper sequence of events to ensure there is no co-mingling of funds and therefore the corporate veil was not pierced. I’ve seen it in the past where individuals pay the debts or by capital goods for their business out of their personal accounts. The second issue that occurs is that any protection of all the other debts that have been accrued for the company no longer exists. Additionally, if a creditor can prove that you are having your customers pay you personally as opposed to the company personal liability can attach for all the other debts because that counts as co-mingling of funds as well.
Therefore it is essential that you ensure you maintain separate accounts, and are very careful as to how money is put into both your corporate accounts and your personal accounts. This does not mean you can’t obtain distributions at the end of the year or quarterly from your company however, any such payments must be made from the corporate accounts and be termed as distributions, or possibly loan repayments.
This blog entry is not exhaustive as to how to protect your corporate veil however; it does touch on the two biggest mistakes most people make. Always ensure that you’re signing on behalf of the company, and always ensure that any monies going to or coming from the company go into or come from the corporate accounts. Maintaining these two basic corporate practices will protect you from the majority of the negative aspects of personal liability in corporate law.
As always, Hewson and Van Hellemont, PC and Timothy M. Kaufman stand ready to assist you in all your business needs. Please do not hesitate to contact our office at (248) 968-5200 or Mr. Kaufmann directly at firstname.lastname@example.org.