“Piercing the Corporate Veil” in Minnesota

In my previous post about the importance of maintaining certain corporate “formalities,” I touched on the concept of “piercing the corporate veil.” One of the main reasons – if not the only reason – entrepreneurs form a company is for the limitation of liability. Business owners want to protect their personal assets from claims made against the company. Forming a separate legal entity for a company creates a border between the owners’ personal assets and the assets – and liabilities - of the company. This separation, however, is not always properly maintained, and potential plaintiffs may seek to “look through” the company as a separate legal entity and hold the owners personally liable for the liabilities of the company – a concept referred to as “piercing the corporate veil.”

Courts do permit plaintiffs to pierce the corporate veil, but only under limited circumstances. After the following review of the standards Minnesota courts use in determining when to pierce the corporate veil, I list some practical advice for business owners to minimize the risk of potential “veil-piercing” claims.

Minnesota Common Law

The standards used by Minnesota courts to determine when to pierce the corporate veil are common law standards, not statutory, which have developed over time through court decisions. Minnesota courts apply a two-pronged test to determine whether to pierce the corporate veil:

1. The Minnesota Supreme Court’s decision in Victoria Elevator Co. of Minneapolis v. Meriden Grain Co., Inc. (1979) lists several “significant” factors to consider to determine if a company is merely the “alter ego” or “instrumentality” of the individual owner(s):

• • “insufficient capitalization for purposes of corporate undertaking,
  • failure to observe corporate formalities,
  • nonpayment of dividends,
  • insolvency of debtor corporation at time of transaction in question,
  • siphoning of funds by dominant shareholder,
  • nonfunctioning of other officers and directors,
  • absence of corporate records, and
  • existence of corporation as merely facade for individual dealings.”

2. If a number of these factors are present (but not necessarily all of them), there must also be “an element of injustice or fundamental unfairness.”

The Court in Victoria Elevator stated that:

“Where the above factors are present, to allow an individual to escape liability because he does his business under a corporate form is to allow him an advantage he does not deserve. Doing business in a corporate form in order to limit individual liability is not wrong; it is, in fact, one purpose for incorporating. But where the formalities of corporate existence are disregarded by one seeking to use it, corporate existence cannot be allowed to shield the individual from liability for damages incurred by those dealing with the corporation.”

Practical Advice for Business Owners

The factors listed above are not exclusive, and no one can guarantee what a court will or will not do. However, a business owner can minimize the risk of exposing his or her personal assets to the claims of a creditor or potential plaintiff by taking certain steps, some of which include:

1. Consistently maintain proper corporate formalities. The Board of Directors/Board of Governors and the shareholders/members of the company, when required by the corporate governance documents, should properly approve all major corporate transactions before or concurrently with the transaction. Shareholders/members should hold annual meetings (or take annual written action in lieu of meetings) to elect (or re-elect) directors/governors and ratify any corporate actions that occurred in the past year. The directors/managers should hold annual meetings to elect officers/managers. Changes in ownership, including new stock issuances, should be approved and documented. There are several more examples of the types of transactions and occurrences that a company should document. Proper and complete corporate records show that the owners of the company are maintaining the line between the company and the individual owners.
2. When signing documents for the company, officers and managers should always include their title. For example: “Gordon Gekko, CEO and President.” Including the title indicates the person is signing in his or her capacity as an officer/manager of the company, not as an individual, and that the obligations are the company’s not the individual’s.
3. Do not co-mingle company and individual funds. Owners should avoid writing personal checks or using personal credit cards to pay for company transactions. Companies should have a separate checking account and, if necessary, credit card. Money flowing from an individual owner to the company should be documented as a loan or capital contribution. Money flowing from the company to the owners should be characterized as a dividend, distribution, or loan. (Consult with your tax professional for advice on these matters.)

There are many other examples, but in sum, business owners must remember that limited liability is not guaranteed, and can be lost with careless business practices.