Architects, engineers and other construction professionals, like all business owners, create business entities, like corporations and limited liability companies, to operate their businesses and to shield themselves from personal liability. The liability shield is a primary benefit of establishing a business entity, because it protects the business owner and the officers and directors of a corporation from personal liability for acts of the company. However, merely forming a corporation is not necessarily sufficient to avoid personal liability, since it is possible to “pierce the corporate veil” if a business does not maintain a separate identity from its owners or related entities.
What is veil piercing?
“Piercing the corporate veil” is a legal term to describe a claim against an owner or shareholder of a company for acts of the company resulting from the failure to observe corporate formalities. Once the corporate veil is pierced, a plaintiff can pursue the personal assets of the business owners to satisfy debts or liabilities of the company.
When Can the Shield of the Company be Pierced?
In Sturkie v. Sifly, the South Carolina Court of Appeals created a two-prong test to determine when it is appropriate to pierce the corporate veil. The first prong of the test is an eight-factor analysis that “looks to observance of corporate formalities by the dominant shareholders.” The eight factors include:
- Whether the corporation was grossly undercapitalized;
- Failure to observe corporate formalities;
- Nonpayment of dividends;
- Insolvency of the debtor corporation at the time;
- Siphoning of funds of the corporation by the dominant stockholder;
- Lack of functioning of other officers or directors;
- Absence of corporate records; and
- Fact that shows that the corporation was merely a façade for the operations of the dominant shareholder.
For a court to disregard the corporate form, a plaintiff must show that a number of the eight factors exist, but the plaintiff does not have to prove every factor. In particular, the courts attach importance to the undercapitalization of the entity and the siphoning of corporate funds for the personal use of the owner or owners.1
The second prong of the Sturkie test is whether the plaintiff who is seeking to pierce the corporate veil will “suffer injustice or fundamental unfairness” if the corporate identity is allowed to stand. Generally, courts are reluctant to disregard the integrity of the corporate entity. Courts are willing to pierce the corporate veil where there is an “element of injustice or fundamental unfairness if the acts of the corporation be not regarded as the acts of the individuals.” In particular, courts have been willing to pierce to corporate veil when the corporate entity “is used to protect fraud, justify wrong or defeat public policy.”
How do I protect myself?
First, on formation, any business entity must be properly capitalized with sufficient funds to engage in its business. Second, a corporation and its owners must maintain separation between the assets of the corporate entity and the assets of its shareholders or members. In other words, the corporate entity and its owners/members must not commingle assets and the owners cannot treat the corporate accounts as their personal bank accounts. These first two factors are the most important for veil piercing in South Carolina, since our courts have shown a particular willingness to disregard the corporate form where corporate funds are siphoned for personal use, commingled, or the corporation is inadequately capitalized.
If a business owner forms or operates a corporation or LLC, that entity should observe all corporate formalities. Directors should be elected by the shareholders and officers duly appointed. The corporation should follow its bylaws and all applicable statutes regarding record keeping and meetings, such as holding yearly shareholders meetings and maintaining minutes of the meetings of the Board of Directors and of the shareholders. If possible, the corporation should have more than one officer and director and the officers and directors should be actively engaged in the operations of the company. The same applies to limited liability companies – such an entity must be careful to abide by the terms of its operating agreement. A corporation or LLC must take care to maintain formal and complete business records that are separate from those of its shareholders or members. Lastly, when forming a small corporation, it may be worth considering a statutory close corporation, which is immune from veil piercing actions for failure to follow corporate formalities. S.C. Code Ann. § 33-18-250.1 Careful observation of corporate formalities is key to avoiding personal liability for the actions of a company.
If you have any questions about how to protect yourself from personal liability or other corporate issues, please call Gibbes Burton at (864) 327-5000. We would be glad to assist you!
1 In Hunting v. Elders, 359 S.C. 217, 597 S.E.2d 803 (Ct. App. 2004), the Court of Appeals recognized that several of the Sturkie factors now have less importance due to changes in state corporate law and federal and state tax law – most particularly, the advent of the statutory close corporation. The factors that now carry less weight are the failure to observe corporate formalities, the nonfunctioning of other officers or directors, the absence of corporate records and the nonpayment of dividends. Id.
2The failure of a statutory close corporation to observe the usual corporate formalities or requirements relating to the exercise of its corporate powers or management of its business and affairs is not a ground for imposing personal liability on the shareholders for liabilities of the corporation.