January 05, 2012 BY Gary Beelen
Protect Yourself At All Times: Wear A Veil
One of the first decisions a prospective business owner needs to make, especially self-employed or small business owners, is the proper business form through which they will conduct their business. Though there are many factors to be considered when deciding whether to operate as a corporation, limited liability company, or other form, two fundamental concerns are prevalent: (1) under which form will I pay the least amount of taxes; and (2) which form will best protect me and my personal assets from liability. Frequently, the self-employed or small business owner will elect, for good reason, to operate as a corporation or limited liability company to address these concerns. With respect to liability, the "corporate veil" protects both the shareholders of a corporation from personal liability and the members of limited liability companies from personal liability for the debts of the separately maintained legal business entities. Yukon Partners, Inc. v. Lodge Keeper Group, Inc. , 258 Ga. App. 1, 5-6 (2002). Too often, however, the concerns and considerations that led the business owner to incorporate or form a limited liability company are quickly forgotten once the day-to-day demands of business operations begin, and basic record keeping gives way to generating business, satisfying orders, and placating customers. In doing so, the business owner erodes and potentially eliminates the protections afforded by the corporate veil, thereby needlessly exposing himself and his personal assets, not only the business’ assets, to liability. Of the multiple hats the self-employed or small business owner must wear to run a profitable business, few are more frequently ignored and less appreciated (until after the fact) than the corporate veil. Thankfully, preservation of the corporate veil requires very little effort by the business owner, and Georgia’s courts have historically gone to great lengths to preserve it.
The benefits of being a self-employed or a small business owner are substantial. As any self-employed or small business owner will attest, however, the effort required to operate a profitable business is likewise substantial, if not daunting. Furthermore, even after you attain the promised land of “profitability,” there always seems to be someone or something lurking in the shadows to “wet their beak” at the expense of your hard earned profits. Much of the time, there is little that can be done, and these inconveniences are simply the cost of doing business. No matter how hard a business owner may try, disputes with vendors, service providers, and even customers are an inevitable reality of business. Under the best of scenarios, such disputes are resolved amicably and relationships are preserved. Some disputes, however, cannot be so resolved, and result in litigation. In such cases, damage control becomes paramount. Generally, only the assets of the business will be exposed to liability by virtue of the corporate veil. In certain cases, however, a plaintiff may “pierce the corporate veil” and collect upon a judgment from not only the business’ assets, but the business owner, personally, and/or the business owners’ personal assets as well. The devastating consequences of such can easily be avoided, however, by consistently adhering to a few basic fundamentals throughout the course of a year, not just after a dispute escalates to litigation.
The concept of piercing the corporate veil actually involves three separate legal theories, any of which separately or in combination could expose the business owner to personal liability. The first involves the “alter ego doctrine.” Under the alter ego doctrine, equitable principles are used to disregard the separate and distinct legal existence possessed by a corporation where it is established that the corporation served as a mere alter ego or business conduit of another. Amason v. Whitehead, 186 Ga. App. 320 (1988). The second theory is “apparent or ostensible agency.” Under this theory, a plaintiff can pierce the corporate veil and expose the business owner to personal liability by showing that: (1) that the owner held out another as his, not the business’, agent; (2) that the plaintiff justifiably relied on the care or skill of the alleged agent, not the business, based upon the business owner’s representation; and (3) that this justifiable reliance led to the injury. Richmond County Hosp. Auth. v. Brown, 257 Ga. 507, 508 (1987). The third method of piercing the corporate veil is through a joint venture theory. The theory of joint venturers arises where two or more parties combine their property or labor, or both, in a joint undertaking for profit, with rights of mutual control (provided the arrangement does not establish a partnership), so as to render all joint venturers liable for the negligence of the other. Boatman v. George Hyman Constr. Co., 157 Ga. App. 120, 123 (1981).
To pierce the corporate veil, a plaintiff must establish that the corporate arrangement was a sham, used to defeat justice, to perpetrate fraud, or to evade statutory, contractual or tort responsibility. Hayes v. Collins,245 Ga. App. 704, 705 (2000). The most common, and generally the easiest, method for a plaintiff to pierce the corporate veil is by showing that a corporation “ignored the corporate form,” i.e. was simply the alter ego of the business owner. This can be accomplished by showing that the entity failed to have meetings, failed to take minutes of meetings, failed to adhere to requirements in the execution of documents as required by the business’ governing documents, and/or failed to maintain officers and/or a board of directors as required by statute and/or the business’ governing documents, to name a few. Though proof of the foregoing alone is generally not sufficient to pierce the corporate veil, it is an easy matter of diligence for a business owner to avoid providing a plaintiff with such “low fruit” evidence. Georgia law sets forth a few specific requirements for corporations, including without limitation those set forth above, necessary to preserve the corporate form and thus the protections afforded by the corporate veil. Many of these requirements may be modified or even dispensed with through shareholder agreements, but the existence of any such shareholder agreements must be “noted conspicuously” on the shareholder certificates. O.C.G.A. §14-2-732. It may seem more convenient in the short-term to dispense with meetings or cut corners to save time and money, but in the long run, adherence to these basic requirements may be all that stands between you and personal bankruptcy. It only takes one judgment to destroy a lifetime of work.
Though the requirements for limited liability companies are much more flexible (and less established at law) with respect to the foregoing formalities, the common thread with preserving the corporate veil among limited liability companies and corporations is “separateness.” Under the alter ego doctrine, Georgia courts will pierce the corporate veil where a corporation or limited liability company is used as a mere subterfuge for the owner’s personal affairs, where the owner has over extended his privilege in the use of a corporate entity and there is such a unity of interest and ownership that the separate personalities of the corporation and the owners no longer exist. Baillie Lumber Co. v. Thompson, 279 Ga. 288, 289-290 (2005). One of the most common examples of this is where the business to so undercapitalized that it cannot reasonably be expected to pay its debts. Since a plaintiff must also show that the business owner undercapitalized the business with the intent of avoiding future debts, records should be maintained to reflect that disbursements were made pursuant to the businesses’ governing documents and for legitimate business purposes. Hickman v. Hyzer, 261 Ga. 38, 40 (1991). Under the business judgment rule, there is generally no liability for bad business decisions, but there may be for decisions based upon the personal interests of the owner, rather than those made in the best interests of the company.
Another method of showing the unity of interests between an owner and the business entity is the commingling of funds on an interchangeable or joint basis. Fuda v. Kroen , 204 Ga. App. 836, 837 (1992). Though business equipment may, under certain circumstances, be used for personal purposes on an occasional basis, disbursements of funds from the business to pay the personal debts of the owner or for other personal benefit should be avoided unless authorized and effected according to the businesses’ governing documents. Likewise, in an example of “no good deed goes unpunished,” the business owner should not inject cash into the business without documenting such as a capital contribution, loan, or other method authorized by the governing documents.
The foregoing is merely an overview of the corporate veil, and a few of the common mistakes made by self-employed and small business owners that erode the protections afforded thereunder. As with all questions related to your and your businesses legal rights and duties, consult legal counsel to make sure you are protected at all times.
The Journal is a publication for the clients of Drew Eckl & Farnham, LLP. It is written in a general format and is not intended to be legal advice to any specific circumstance. Legal Opinions may vary when based upon subtle factual differences. All rights reserved.
H. Michael Bagley