Business Entity Separate From Owner?
Nevada subscribes to the old adage that “if it looks like a duck, swims like a duck, and quacks like a duck, then it’s probably is a duck”. If a person’s company looks like nothing more than an extension of the company’s owner(s), then the court may disregard the company as a separate entity form its owner(s).
Incorporation Alone Will Not Protect Your Personal Assets From a Business Lawsuit
Many attorneys recommend incorporating a business in an effort to lower the chances of a business owner’s personal assets being used to satisfy a judgement against the owner’s business. But incorporating a business will not have the desired asset protection value if a business owner treats his corporate business as simply an extension of his personal life. In other words, if a judge looks at a business and determines that a business owner has not treated it as the separate entity it was intended to be, then the judge may disregard the corporate structure and allow a plaintiff who has sued the business to go after the personal assets of the owner. This is called “piercing the corporate veil”.
Nevada’s Alter Ego Doctrine As Codified In NRS 78.747
In Nevada piercing the corporate veil is accomplished under a legal theory call the “Alter Ego Doctrine”. See McCleary Cattle Co. v. Sewell, 317 P.2d 957 (1957). As it relates to corporations, this doctrine was codified in NRS 78.747 which states:
- Except as otherwise provided by specific statute, no stockholder, director or officer of a corporation is individually liable for a debt or liability of the corporation, unless the stockholder, director or officer acts as the alter ego of the corporation.
- A stockholder, director or officer acts as an alter ego of a corporation if:
a. The corporation is influenced and governed by the stockholder, director or officer; b. There is such unity of interest and ownership that the corporation and the stockholder, director or officer are inseparable from each other; and c. Adherence to the corporate fiction of a separate entity would sanction fraud or promote a manifest injustice.
Issues Considered In An Alter Ego Case
There is no litmus test to determine whether “there is such unity of interest and ownership that the corporation and the director or officer are inseparable from each other”. The court will look at a number of factors and weigh the totality of evidence presented to it. Issues that are often looked at in an alter ego case are undercapitalization, loans from the business to the owner without sufficient evidentiary paperwork or consideration, the owner using corporate assets for personal matters, and failure to observe corporate formalities.
I recommend that my clients maintain corporate formalities on a regular basis. On the annual renewal date of the corporations I set up, I ask my clients to review their records to make sure the corporate formalities have been complied with throughout the year. I ask them to review the following:
1) Shareholders Meeting.
Shareholders of the corporation should meet regularly, and a record of the meeting should be kept by the Secretary. The he Shareholder’s should hold an election for the Board of Directors of the Company at least annually.
2) Board of Director’s Meeting/Corporate Minutes.
Once the Board of Director’s has been elected, the Board should have regular meetings and minutes should be taken by the Secretary and recorded in a corporate minute book. These corporate minutes should reflect the resolutions passed by the board of directors and should reflect every major decision made by the company.
3) Corporate Bylaws.
Every corporation should have bylaws that were formally adopted by the corporation which lays out how the corporation is to be governed.
4) Sign Documents in Representative Capacity.
If you are an officer of a corporation, you should sign in your official capacity on any contract you do not wish to have personal liability for. All signatures should have your title after your name to make clear that you are signing as a representative of the corporation and not at as an individual only.
5) Separate Bank Accounts and Separate Books.
Comingling of corporate and personal funds is a major mistake and can easily lead to piercing the corporate veil. All businesses must keep separate books and have separate bank accounts. I have seen some business owners try to cut down on administrative costs by combining the books and bank accounts of their multiple businesses. This is a mistake!
6) Stock Certificates.
Some small companies with very few shareholders fail to issue stock certificates because the owners do not see a need for it. But the issuance of actual stock certificates will show a judge that you are operating your corporation as it should be operated. Such evidence will strengthen your argument that the alter ego theory does not apply to your case.
7) File Taxes.
All corporations should file a tax return separate from the owner. All businesses should utilize the expertise of an accountant when it comes to their taxes.
8) Create Contracts.
I do not recommend corporations give loans to their owners or operators, nor do I like loans to relatives of owners or operators. Nevertheless, it is not illegal to do so. If a business chooses to make a loan to anyone a proper promissory note for the repayment of the loan should be prepared and signed by the proper parties. The terms of loan document should also be strictly complied with by the parties. This same formality should also apply to any lease agreements or other types of contracts entered into between corporations and those close to the corporations’ owners and operators. Written contracts will help keep clear lines between corporate affairs and the personal affairs of the directors, officers, and shareholders.
9) Have active corporate officers.
Taking a position with a company brings certain fiduciary duties. Officers and directors have a duty to be informed and active in the business. Records should be kept to indicate that all officers and directors are informed and active in the business. The above is not an exhaustive list, but will aid the reader in understanding the type of evidence a judge will look at when determining whether to apply the Alter-Ego theory to a given case.
Play It Safe As an LLC and Observe Corporate Formalities
Nevada limited-liability companies are governed by NRS Section 86, and there is no statutory adoption of the alter-ego theory in Section 86 like is there for corporations. Nevertheless, most attorneys believe, and some courts have held, that the alter-ego doctrine is available to pierce the veil of LLCs. For this reason, I recommend the same corporate formalities for LLCs as I do for corporations. Attorneys, myself included, will claim that such formalities are not required for an LLC. Indeed, one argument asserts that one of the reasons the LLC entity was created was to do away with the numerous formalities of a corporation. But because it is unclear how a particular court will treat an LLC when faced with an alter-ego argument, I consider it best to play it safe and keep the formalities. I always recommend the adoption of an operating agreement to set forth the rights and responsibilities of the members of the LLC. I also recommend regular meetings of the members and consistent written minutes of the meetings.
Substance Holds More Weight Than Form
It is important to make your business look like what you want it to be treated as by a court. Judges tend to look at substance over form and they will disregard a company’s corporate form if its owners do not maintain it and treat it as a totally separate entity.