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  • Northeast Wisconsin
  • July 2018
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Piercing the veil

Business owners have business assets and personal assets. Duh!

I make that obvious statement for a reason, though. As I get into the “meat and potatoes” of these articles, I don’t want the ideas to distract from the bottom line. The information is only relevant because business owners want to maintain that distinction — that line — between business assets and personal assets.

How does someone obtain that line of distinction?

Here’s what you do: Grab a blank piece of paper out of your printer and begin thinking of all the things that your business owns — or will own once you start it. Now, organize those things into a list (on the left side of the page) from most expensive to least expensive. Then, on the right side of the page do the same for your personal assets. Now — this part is critical — find a Sharpie Fine Point Permanent Marker; and, with a ruler, draw a perfectly straight line in between your two lists. Viola! One distinct line between your business assets and your personal assets.

Just kidding. What you need to do is set up a legal entity (probably an LLC or corporation).

Why is a legal entity important?

Suppose Joe Schmoe is a really wealthy guy. He made his millions the old-fashioned way: struck it big on the lotto. Now he’s bored, so he decides to buy a very small mom and pop bakery (Schmoe Sweets, LLC), because he loves to bake desserts. He has no employees, it’s just him. One day, he mops the floor in front of the display case, and as he’s going to grab the “Caution Wet Floor” sign, a young boy slips and severely injures himself. The young boy’s parents sue Joe Schmoe.

What happens next?

  1. The attorney representing the little boy is only able to come after the small amount of assets that the business owns.
  2. The attorney representing the little boy comes after the assets of the business and a huge chunk of Joe’s lottery winnings.

*The answer is “a” if Schmoe Sweets, LLC is set up as a perfectly legitimate legal entity, and is used properly.

*The answer is “b” if Joe Schmoe did something wrong when he set up the entity, or if he is doing something wrong now!

Guess what? It is literally in the attorney’s job description to figure out if Joe did anything wrong.

Six mistakes that lead to piercing the veil

Young boy slips in Joe’s bakery and severely injures himself. The boy’s attorney will ask the following questions:

1. Is the entity operating as a legitimate business?

Fail: Joe bought the business and realized that he didn’t really know how to run a business — he just likes baking — so he only opens up the bakery on Sundays for members of his church to enjoy free treats and socialize before/after church.

2. Is there commingling of assets?

Fail: Joe took out a company credit card when he started Schmoe Sweets, LLC. The card earns him 4 percent cash back on all purchases, so he uses it for everything, including personal expenses like dining out, groceries and home repairs.

3. Is the company undercapitalized, or was it undercapitalized at formation?

Fail: Joe set up a bank account in the company’s name, but normally maintains the minimum balance of $100. Bank records show very little activity in the account since it was opened. Accounting records indicate that the business costs $2,000 per month to operate.

4. Is the company a “shell” of the business owners?

Fail: Joe’s business cards, email signature, stationary, menus and website all say, “Treats by Joe Schmoe.” There is minimal effort to identify his entity: Schmoe Sweets, LLC.

5. Does the company disregard the operating agreement/bylaws?

Fail: Joe’s operating agreement states that all corporate records are to be held at his principal place of business. Joe, instead, keeps his corporate records at his cabin up north, for safekeeping.

6. Is the business being used to defraud creditors or avoid legitimate claims of creditors?

Fail: Joe knows he is about to be sued. He shuts down Schmoe Sweets, LLC and transfers all of its assets to a new LLC: Joe Mama’s Bakery, LLC.

Understand that these are mere examples of situations that could lend a creditor to pierce the veil. In all judgements, it will be the task of the judge/jury to weigh the balance of the facts in question. This means that in most cases, business owners will need to fail more than one test to be exposed. Finally, it is important to remember that fraudulent acts on the part of a business owner will automatically bypass the corporate structure. 

Kelton Dopp

Kelton Dopp started his career as a Financial Advisor, prior to joining Epiphany Law’s team as a Project Specialist in 2017. One of his greatest passions in life is finding ways to make the complex simple. Epiphany Law, LLC. Is located at 4211 North Lightning Drive, Appleton. For more information, email [email protected] or call 920-996-0000.

 

Website: epiphanylaw.com
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