What is “Piercing the Corporate Veil” and Why Does Every Business Owner Need to Avoid It?

By Charlie Carlin, Fortis Law Partners

Piercing the corporate veil is an important legal and business concept many entrepreneurs aren’t familiar with. Business owners put a lot of blood, sweat and tears into making their company successful. Hopefully, things go well, the company grows and is profitable. However, sometimes things go wrong, and the business gets sued. Unfortunately, many entrepreneurs don’t know they could personally end up on the hook for any financial damages awarded in a lawsuit.

Fortunately, in Colorado, company owners are usually protected from being held personally liable for damages awarded in a lawsuit. Specifically, in Colorado, a company (including an LLC) “is a legal entity distinct from its shareholders,” insulating its owners from personal liability based on the company’s acts.[1] Indeed, such “[i]nsulation from individual liability is an inherent purpose of incorporation,” and “only extraordinary circumstances justify disregarding the corporate entity to impose personal liability” on the company’s owners.[2]

Clearly, there are some instances where a business owner can be held personally liable for financial damages. What kinds of “extraordinary circumstances” might justify that happening? If the business owner has “pierced the corporate veil,” the court will likely conclude that they should be held personally responsible for financial damages.

Piercing the corporate veil means disregarding the company’s corporate form. To determine whether or not a business owner has pierced the corporate veil in Colorado, the courts must conduct a three-part inquiry consisting of the following questions: 

1. Is the company the “alter ego” of the owner?
2. If the company is the alter ego of the owner, was the company used to “perpetrate a fraud or defeat a rightful claim”? 
3. Would disregarding the corporate form and holding the owner personally liable for the company’s actions achieve an “equitable” result? [3] 

For an owner to avoid being held personally liable for the company’s actions, they must first be able to prove to the court that the company is not the “alter ego” of the owner. To determine the answer to this question, the courts will consider the following eight points: 

1. Does the company operate as a distinct business entity from the owner?
2. Do the company and owner commingle funds and assets?
3. Does the company maintain adequate corporate records?
4. Does the company’s ownership and the way the company is controlled potentially facilitate misuse of the company by the owner?
5. Is the company used as a mere shell for the owner’s interests?
6. Is the company thinly capitalized?
7. Does the company disregard legal formalities?
8. Does the company use corporate funds or assets for non-corporate purposes[4]?

Reviewing this list should clarify if immediate changes are needed to avoid potentially piercing the corporate veil and being held personally liable for your company’s actions in a lawsuit. 

There are five essential things every business owner should do to help decrease the risk of that happening.

• First, maintain separate bank accounts for you and your company, and do not carelessly move money between those accounts to pay for personal things.
• Second, maintain the corporate records required under Colorado’s relevant laws. 
• Third, ensure that your company follows the required legal formalities. For example, holding shareholder meetings and maintaining records of the meetings are requirements for certain companies. If that applies to your company, ensure that they actually occur. 
• To the extent possible, maintain sufficient funds to meet company obligations and establish an adequate financial cushion for unexpected expenses.
• Do not use the company’s funds for personal use, i.e., buying a Ferrari from the company coffers.

Each of the examples listed above can provide you with significant legal cover and decrease the chances that if your company gets sued, you will be held personally liable for damages because you have pierced the corporate veil. 

[1] Stockdale v. Ellsworth, 2017 CO 109, ¶¶ 18-19, 407 P.3d 571, 576.

[2] Id. (quoting Leonard v. McMorris, 63 P.3d 323, 330 (Colo. 2003)).

[3] Dill v. Rembrandt Grp., Inc., 2020 COA 69, ¶¶ 28-31, 474 P.3d 176, 183–84, reh’g denied (May 7, 2020), cert. denied, No. 20SC460, 2020 WL 6325871 (Colo. Oct. 26, 2020).

[4] Id. at 183.