After years of success as a medical device salesperson, Debby decides to take the next step and start her own distribution company. She knows her industry, and she has numerous contacts to develop.
Debby has lots of lawyer friends, so she knows she must create a corporation or an LLC. She chooses to go with a C corporation because she has heard that brings tax advantages, and she plans on going big. And she especially likes that the corporation will take all the liability if something happens, so that her personal assets will be protected.
The business is a success, and she starts making a lot of money. Debby has no accountant, but she keeps her books very closely and accurately. Accountant friends asked about her plans for shareholders, but things were going too well to worry about that. Because it was her working pretty much alone, Debby did not worry about a board of directors or the annual reports. She used her credit cards for almost all expenses, from airline tickets for business trips to furniture for her home.
Then trouble hit. One of the devices she was selling killed some of the people who used it, and the result was a huge class action lawsuit. Debby was only one of many defendants, but the lawsuit was so large that, if she were deemed to be liable, the damages would be more than her company could withstand.
Debby was heartbroken at the prospect of losing her company, but she congratulated herself on her wisdom in creating the corporation so that her personal assets would be safe.
What happened? She lost the lawsuit, and the plaintiffs took not only all the corporate assets but also all of Debby’s personal assets. How could they do that?
The plaintiffs “pierced the veil” of the corporation. Simply stated, if the corporation is not treated as a distinct entity, the corporate protection will be pierced and the owner’s assets will become vulnerable.
What did Debby do wrong? Debby was required to hold director meetings, but she never set up a board of directors. She was required to hold and record an annual meeting, whether there is any real value to such a meeting or not, and she did not do it. She was required to keep corporate and personal funds separate, but she commingled them, using the same source to pay both corporate and personal expenses.
None of these things seemed important at the time. She knew she was operating honestly and taking care of the big things. But she lost everything anyway.
Are you vulnerable in running your corporation or LLC? If so, stop. If you’re not sure, see an Arizona contract lawyer.