Corporations and limited liability companies (LLCs) provide significant liability protection to their owners. Shareholders of corporations and members of limited liability companies generally are not responsible for debts of the corporation or LLC. A recent Ohio case, however, serves as a reminder that creditors may attempt to "pierce the corporate veil" and hold an owner individually liable for debts of the entity.
In RCO International Corporation v. Clevenger, 180 Ohio App.3d 211 (2008) the Plaintiff brought a breach of contract action against an LLC and its two members. While the lower court granted summary judgment in favor of the owners, an Ohio appeals court held that the creditor may have made sufficient allegations against the owners, to sue them personally. While the Plaintiff did not allege fraud, it did allege an illegal act (the company’s sending a false invoice). On the surface, the facts of this case did not seem to present a strong case for "piercing the corporate veil". The decision, however, may have rested on certain procedural issues. In any event, this recent case is a good reminder that simply forming a corporation or LLC does not in and of itself automatically give the owner limited liability in all circumstances.
What can be done to prevent a creditor from "piercing the corporate veil" and holding an owner personally liable?
- Make sure your corporation or LLC is properly set up. If you are setting up an entity without the help of an attorney, you may not be taking all the necessary steps to make sure that the entity is properly formed.
- Observe formalities once the entity is formed. Corporations should hold annual meetings of shareholders. There should be meetings of the Board of Directors. An LLC should have an Operating Agreement, and the terms of that Operating Agreement should be followed. Your entity should have a separate bank account and be treated as a separate entity.
- Your corporation or LLC should have usual and customary insurance for whatever business it is conducting. A court is far more likely to try and "pierce the corporate veil" if the owner has intentionally failed to provide customary insurance for the entity’s activities.
- Follow good business practices. Forming an entity will not shield an individual owner from fraud or illegal acts.
The leading court decision in Ohio, Belvedere Condominium Unit Owners Association v. R.E. Roark Companies, 67 Ohio St. 3d 274 (1993), as well as decisions in many other states, make clear that if usual and customary practices are followed, a corporation or an LLC should provide limited liability protection for its owners.