15 years ago, Diana hired a lawyer to create a corporation when she opened her yoga studio. In the years since incorporating, she’s been busy running the studio, and has never thought about the corporation besides filing her annual registration.
Diana’s yoga studio has been struggling financially. There’s not much money in her business account and so she often pays her studio expenses out of her personal checking account. When there is money in the business account, she sometimes uses it to pay her home mortgage.
She just got served with a lawsuit from her studio’s landlord. She’s considering filing bankruptcy for her business to get out of the lawsuit. Since there’s not enough funds in the business account, she could just walk away from her lease, right?
Well, not so fast. A primary advantage of setting up a separate legal entity like a corporation is the protection against personal liability for the owner. It’s a special perk that allows the owner to shield personal assets, like a house, investment accounts and such, from the liabilities of the business. That is, if the business is sued or has debts, and there’s not enough money in the business account or business insurance to cover them, then the owner will not have to pay for those obligations out of pocket.
That protection is the way it’s supposed to work.
But often, owners skip or forget to do what they need to do, and so they may lose that advantage. In some situations, a judge could decide to make the owner personally liable for the business liabilities because there is not enough separation between the owner and the company. It’s called piercing the corporate veil.
Diana is at risk because she has not maintained proper separation between herself and her company. She has been comingling her personal funds with her business funds, and not keeping adequate accounting records. She also has not followed the corporate formalities like holding regular meetings and formally documenting her business decisions. Her prospects of success with this lawsuit are not great.
Sometimes, casual business decisions can turn into serious problems down the line.