The main purpose of forming a separate legal entity to operate a business is the protection of personal assets. This multi-part series of articles will discuss in detail the proper use of the corporate form. These articles will hopefully help you avoid common mistakes that could expose your personal and family assets.
Part One
Overview – How Your Personal Assets Can Be Exposed
So long as your business follows the correct procedures, and avoids the pitfalls that will be discussed below, the courts will uphold the corporate form. Your personal assets will be exposed to creditors of your business where there is what’s referred to as a “piercing of the corporate veil”.
Your business entity is protected if you have a corporation or an LLC. Pennsylvania’s Corporations and Unincorporated Associations Act, 15 Pa.C.S. § 8900, et seq., provides that limited liability companies are treated in the same manner as corporations. In this respect, the members of the limited liability company (just like shareholders of a corporation) are not liable for the debt or obligation of the entity, absent extraordinary circumstances. 15 Pa. C.S. § 8904 (b) and comment b.
In order to surpass the strong presumption in Pennsylvania against piercing the corporate veil, a plaintiff or creditor of your business must try to prove the following:
- The company was undercapitalized at the time of the incident or debt;
- The company failed to adhere to required corporate formalities;
- There was a substantial intermingling of corporate and personal affairs between the company and the owners of the company; and
- The owners of the company used the corporate form to perpetrate a fraud.
These are known as the Lumax factors, from the seminal 1995 Pennsylvania Supreme Court case, Lumax Industries, Inc. v. Aultman. [1] These factors will all be considered and will be weighed differently, on a case-by-case basis.
In Pennsylvania, piercing the corporate veil is permitted in extraordinary circumstances to get at the assets of the owners of the entity. There is a strong presumption in Pennsylvania against piercing the corporate veil. In applying the Lumax factors to determine whether the corporate veil should be pierced, the Court must start from the general rule that the corporate entity should be recognized and upheld, unless specific, unusual circumstances call for an exception. “Care should be taken on all occasions to avoid making the entire theory of corporate entity … useless.”[2]
A Court should pierce the corporate veil only when the corporation was an artifice and a sham to execute illegitimate purposes [and] abuse of the corporation fiction and immunity that it carries.
Part two of this series will address how the intermingling of funds will expose your personal assets and how to avoid that.
As this is an exceptionally complicated area of the law, it is imperative that you consult with your attorneys to assure the proper formation and use of the corporate form in order to protect your personal assets.
Robert A. Burke is a partner in the law firm of MacElree Harvey, Ltd. He handles complex commercial and estate litigation matters.
To schedule a consultation, call (610) 840-0211 or email [email protected].
[1] Lumax Industries, Inc. v. Aultman, 669 A.2d 893, 895 (Pa. 1995) (emphasis supplied).
[2] Zubik v. Zubik, 384 F.2d 267, 273 (3d Cir. 1967)
