Fraud and Commingling Can Kill the Corporate Veil
As a business owner of a Texas entity, you have made many decisions prior to formation, including taking the initial step to legally form an entity. By forming the entity, filing with the Texas Secretary of State, preparing governing documents, and holding meetings, the entity is held out as separate and apart from its founder.
Courts recognize a legal concept called a “corporate veil” that acts as a shield for the owner, officers and shareholders from liability owed by the entity. Additionally, the corporate veil can be utilized to separately protect a parent company and its subsidiary company from each other’s liability.
Courts can pierce the corporate veil.
In a lawsuit, a plaintiff who is suing the entity may request the court to “pierce the corporate veil” and allow recovery from the corporation’s key people - owner, directors and shareholders. A court can allow for such relief when there is a finding that the key people abuse the corporate privilege. One such circumstance is when a plaintiff can prove that the corporation was used for the purpose of perpetrating an actual fraud on the plaintiff for the direct benefit of the owner, shareholder, affiliate. See In re Pace (Osherow v. Hensley), 2011 WL 1870054 (Bankr. W.D. Tex. May 16, 2011), wherein the court found that Hensley, who solely controlled his LLC (limited liability company) had not acted in good faith in a transfer of a condominium and was jointly and severally liable with his LLC.
Without the formalities of maintaining a separation between personal dealings and business dealings, a bankruptcy court can apply the Alter Ego theory and find, based on the evidence, as with In re Arnette (Ward Family Foundation v. Arnette), 2011 WL 2292314 (Bankr. N.D. Tex. June 7, 2011), that the finances of the debtor and his entities were blended, there was commingling of personal funds with entities’ funds, and the debtor took out loans and distributions for the debtor’s extravagant lifestyle instead of a salary.
Keep your business income and debts separate from personal income and debts. Obtain sound legal advice and use it every day with each important business decision.
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