In a previous post, we discussed the personal liability of business owners for the torts and business debts of the business. As was addressed in that post, the general rule is that owners of an LLC are not personally on the hook for these obligations. That is, afterall, the point of forming such an entity. However, this general rule (like most rules of law) is far from absolute. In very rare circumstances, courts will occasionally ignore the existence of the business entity altogether, and allow a particular plaintiff to hold the owners of the LLC liable as well. This doctrine is known as “piercing the corporate veil,” and it takes its colorful name from the theory that we should look beyond the veil of that is a corporate entity and look directly to the owners of the business for business-related obligations. That is, courts will refuse to restrict a plaintiff’s recovery to the assets of the LLC alone, and permit plaintiffs to a reach the personal assets of the individual owners of the LLC as well.
Courts do not often ignore the existence of a properly formed business entity. After all, the laws of Ohio specifically allow the formation of these various entities in order to encourage business investment. If the courts are going to ignore the legal rights of Ohio business owners, and the collective judgment of the elected legislature,
Perhaps the single most important factor considered by a court in making its determination to pierce the corporate veil is whether or not the LLC is adequately capitalized. This really makes sense when you think about it; nothing raises a red flag to the court, that an entity is just a shell for a member, more so than an LLC that has no real assets.
Unfortunately, even well-intentioned entrepreneurs that prudently sought their attorney’s advice during initial LLC formation are eventually pierced by a plaintiff’s suit due to under capitalization. Countless new businesses lack adequate funds to fully capitalize a new business and in most cases early operations are in the red. Therefore, an insurance policy is the only reasonable means of adequately capitalizing the LLC in the event of a tort liability suit. All too often, the acquiring of insurance is overlooked or ignored during the early stages of business planning, however, could ultimately make the difference in a court’s decision of whether to pierce the corporate veil.
For example, take the following hypothetical: Eddie Entrepreneur decides that he would like to open a public motocross track. Eddie’s primary assets are the 200 acres left to him by his grandfather that he thinks will be prime location for his new track. Next, Eddie seeks counsel from his attorney which advises him that an LLC is a must have considering the high risk nature of a public motocross track, and as such, appropriately suggests that Eddie lease the property to his LLC (as opposed to transferring the property to the LLC). Additionally, Eddie pays himself a reasonable salary out of the Motocross Track LLC checking account that is currently capitalized with 2,000 dollars.
Business is going great for Eddie until a customer gets injured due to Eddie’s negligence and law suit follows. Eddie’s personal liability is shielded by the LLC, right? Maybe not, if Eddie had opted for minimal insurance coverage or no insurance at all, it is quite possible that the LLC would be pierced. Choosing the right insurance policy could mean the difference between effectively protecting your assets and should be a priority of any early business plan.