In Ohio, corporate officers, directors and shareholders are not always immune to personal liability for their corporations’ wrongful acts. Savvy, sophisticated business owners take steps to shield themselves from personal liability by forming corporate entities and subsidiaries, but complete immunity is never guaranteed. In certain limited circumstances, a court may exercise its authority to “pierce the corporate veil,” imposing individual liability on these otherwise protected parties. Veil-piercing cases resulted in personal liability for corporate officers anywhere between one-third to one-half of the time these cases are filed. Using corporations and subsidiaries as tools to limit liability is a legitimate and valuable strategy for corporate risk management, but it must first be understood how the corporate veil may be pierced.
Limited Liability Companies (LLCs)
One strategy businesses use to protect themselves from personal liability is to form a limited liability company (LLC). An LLC establishes a corporate veil of protection, but if pierced, can leave owners, shareholders and directors personally liable if a court determines that officers acted outside the protection of the entity.
Ohio LLCs should take the following steps to avoid a court “piercing the corporate veil” and finding individual officers personally liable for damages and attorney fees:
Stay Compliant with LLC Formalities
As of April 2022, businesses in Ohio should meet the requirements of the Ohio Revised Limited Liability Company Act (Ohio Rev. Code §§ 1706.01-1706.84) to stay compliant with LLC formalities. The act provides the following:
- LLCs must continuously maintain a statutory agent. To learn more about how the statutory agent requirements changed from the previous Act, read here.
- LLCs must keep their statutory agents’ current contact information on file with the Secretary of State.
- LLCs do not need to file annual reports.
Take Steps to Keep a Distance Between Corporate Officers and Their LLC
Ohio courts use the Belvedere Test to determine whether to pierce the corporate veil and impute liability to the owners of an LLC. The Belvedere Test asks three questions:
- Was the LLC just an alter ego for the owners? (Was control over the corporation “so complete that the corporation has no separate mind, will, or existence of its own”?)
- Was control over the corporation “exercised in such a manner as to commit fraud or an illegal act” against the person asking the court to pierce the veil?
- Did the plaintiff suffer injury or unjust loss from the exercise of control and the alleged wrong?
LLCs can lose their protections if they fail to comply with incorporation rules, commingle personal and business assets, divert company assets for personal use or personally guarantee payments of company debt. Directors, officers, members and managers can also be held liable for unpaid wages to employees, unpaid taxes to governments and even shareholder payments authorized without sufficient capital. Personal liability can also arise from fraud, embezzlement and illegal or reckless acts.
Business owners can take comfort in the fact that courts are typically reluctant to revoke a corporation’s liability protections and will generally only do so in cases of severe misconduct.
Subsidiaries are secondary businesses essential to the parent company’s operations. They are controlled by ownership shares and considered separate entities. If any action is taken against a subsidiary, only its assets and capital are subject to liability. Subsidiaries can distribute assets and provide additional protection for the parent company.
However, creating a subsidiary does not make the corporate veil invulnerable. It does not protect against illegal acts, reckless business practices or non-compliance with corporate maintenance rules.
To minimize the risk that a court will elect to pierce the corporate veil of a subsidiary or the parent company itself, businesses should heed these five tips:
- Follow the rules for incorporation and comply with corporate statutes by issuing stock certificates properly, filing required documents on time and adequately funding and insuring the business entity.
- Create separate and distinct accounts for each tier of the organization to maintain separate and independent bank accounts and eliminate confusion.
- Clearly define all transactions that occur between related entities and ensure that each level of the corporate group keeps separate records, books and bank accounts.
- Ensure that each entity has appropriate debt-to-equity ratios and can stand alone as a separate entity.
- Maintain operational distance by having a subsidiary hire and fire its own employees, maintain a separate board of directors and generally operate without direct control from the parent company.
These five points boil down to two main ideas: statutory compliance keeps the corporate structure intact, and establishing separate and distinct identities for each business entity is critical for protection.
According to a study by NERA Economic Consulting, in 2020 the average damages awarded in a veil-piercing case in the United States were $4.5 million. Companies cannot afford not to take proper precautions when it comes to maintaining their corporate protections.
This article was curated for the CuyEast Chamber audience and originally published by chamber member Gertsburg Licata. Want your content published? Visit: cuyahogaeastchamber.org/publish/
This article is meant to be utilized as a general guideline for governing documents for businesses. Nothing in this blog is intended to create an attorney-client relationship or to provide legal advice on which you should rely without talking to your own retained attorney first. If you have questions about your particular legal situation, you should contact a legal professional.