Many new businesses choose to structure their company as a Corporation or an LLC because of the benefit of limited personal liability for shareholders or members. The general rule is that these entities are separate and distinct from their shareholders, and individuals are not personally liable for the obligations of the entity. However, there are circumstances when individuals can be held liable on behalf of the entity through a theory called “piercing the corporate veil.” In Glenn v. Wagner, the court stated that the corporate form will be disregarded “when it is necessary to prevent fraud or to achieve equity.” Also, a shareholder cannot use the corporation to “shield criminal wrongdoing, defeat public interest, and circumvent public policy.”
In North Carolina, courts use the “instrumentality rule” when determining whether to pierce the corporate veil and hold an individual liable. Under the instrumentality rule, a plaintiff must show three elements, (1) the shareholder must have complete domination and control of the entity with respect to the transaction at issue, (2) the shareholder must use this control to commit a wrong, and (3) this wrong must be the cause of the injury to the plaintiff.
There are several factors that courts will consider when determining whether to pierce the corporate veil. Some of the key factors include:
Non-compliance with corporate formalities (e.g. failing to keep accurate corporate records, non-functioning of officers and directors, co-mingling of corporate and personal funds, failing to have board of director’s or shareholder’s meetings);
Inadequate Capitalization of the Corporation (e.g. siphoning corporate profits to the majority shareholder, leaving the corporation an “empty shell”); and
Complete Domination and Control of the Corporation (control to an extent that the corporation is a mere instrumentality or an alter ego of the majority shareholder.).
As you can see, it’s very important to protect yourself from personal liability by respecting your corporation or LLC as a separate entity by avoiding the behaviors mentioned above. Of course, there are always exceptions to general rules, and you should not rely on this blog without consulting an attorney to find out whether and how these laws might apply to your business.
The business attorneys at Asheville Legal are experienced and skilled at advising clients how to protect their corporate veil, so if you have a question about these issues, give us a call today.