I’m taking on a very popular & very common misconception. It deals with corporations and the strength of protection they give. Now, we’ve all heard that corporations offer excellent protection, that they have a corporate veil.
What is a corporate veil?
This corporate veil protects the shareholders from creditors of the corporation provided all the formalities had been met, provided the corporation is adequately capitalized and adequately insured, provided regular meetings are held, provided that all of the statutorily required rules to keep a corporation up and running have been complied with. We’ve paid our fees.
Let’s just pretend we’re perfect and you and I have the same old doughnut shop I keep using. I’m the cook and you’re the investor and we’re splitting at 50-50 and it’s a corporation so we each own 100 shares exactly 50-50. And let’s just assume I’m frying some doughnuts up some morning at 4:00 o’clock and my grease gets on fire and it explodes and it badly disfigures three local cheerleaders from a high school where buying they’re buying doughnuts for their, you know, for their cheerleading society.
Well, believe me these badly injured girls are all going to have great hungry contingent fee litigators jumping at the chance to tear us apart. They’re certainly going to sue the corporation no doubt. Well, who else are they going to sue?
Well, let me tell you. They’re going to sue me and they’re going to sue you and if you’re married, they’re going to sue your spouse. So, that’s just the way it always works. This corporate veil is an illusion with most small companies.
Yes with IBM. If I’m an IBM shareholder and IBM gets sued for some anti-trust violation or gets sued because they made a product that was defective or injured somebody, believe me that’s not going to stop at the corporate level.
They might go to the individual who ran the program that caused the problem. They might even sue some members of the board who or the president alleging that he or she knew or should have known but that’s really tough and it isn’t going to get to the shareholders.
But listen with our little doughnut shop, with our local car dealership, with our local hardware store, they’re going to get right to the people who manage and the people who own the company and they’re going to allege that we either had the power and we should have known that we did have the power and we should have known about the dangerous nature of our fried machine. That’s just the bottomline.
They’re going to nail our spouses that will ruin our sex lives, that they’ll make it so there’s a lot of strain in the marriage. They will do everything to encourage settlement. So, how strong is a corporate veil?
The answer is it’s not strong at all. You should never depend upon it to give you any meaningful protection in a small company.
That’s the bottomline truth and with that said, I love corporations.
Asset protection corporation is a corporation. It’s a sub S corporation which is the worst type of corporation you have if you care about asset protection because it cannot be owned by a foreign trust.
So, I stay away from sub Ss except asset protection corporation never really has any value independent of me. And if I’m dead, it’s pretty much worthless and I decided to take the step of having it as a corporation because it saved me a few dollars in self-employment taxes.
The bottomline is that you should not assume that a small closely-held corporation will give you any meaningful insulation from creditors of the corporation because they’re always going to go after you personally and your spouse.
It’s just the way it’s done. So, keep insurance, do asset protection for your liquidity and your assets that are protectable but don’t think some little corporation is going to do the trick because it simply doesn’t.