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It is generally advisable for business owners to form a separate legal entity to limit personal liability stemming from business contracts or torts. Incorporating or organizing as an LLC can limit owners’ personal liability to the extent of their investments. This liability shield, however, is not without exception. In a recent case from the Iowa Court of Appeals, a plaintiff was able to “pierce the corporate veil” in an attempt to collect on a $410,067 breach of contract judgment. The case provides a good reminder to business owners that they must truly follow statutory requirements for maintaining a true business or they will not receive the protections of those laws.
The defendant was the sole owner and director of an Iowa corporation that had existed for nearly 20 years. His corporation, which was in the business of biosolids management, agreed to provide lagoon sludge removal for the plaintiff, a construction company building a wastewater treatment facility. After beginning work on the project, the corporation abandoned the work. The plaintiff obtained a $410,067 judgment against the corporation for breach of contract, but was unable to collect on the judgment. The plaintiff then filed a new action seeking to pierce the veil of the corporation and recover personally from the defendant, its owner.
The trial court ruled in favor of the defendant, and the plaintiff appealed. The Iowa Court of Appeals reversed, finding that corporate veil should be pierced.
The court first reviewed Iowa law governing piercing a corporate veil. Where a corporation is “a mere shell, serving no legitimate business purpose and used primarily as an intermediary to perpetrate fraud or promote injustice, the corporate veil may be pierced.” Plaintiffs, however, bear the burden to prove exceptional circumstances. Factors supporting such a finding include:
The court found that there was insufficient evidence to support a finding that the business was undercapitalized or purposely underfunded by the defendant. And the court did not even discuss fraud or illegality. The court also held that the corporation, which had operated for many years before failing, was not a mere sham. Even so, the court found that the other factors combined to show that the defendant did not consider the business or its finances to be a separate entity from himself and his other businesses. As such, the court ruled that the corporate veil should be pierced.
The evidence showed that the defendant, while keeping a separate bank account for the corporation, had commingled its funds with his personal finances. He had used the accounts for the corporation and his other businesses interchangeably, with no regard for which company should be providing money for which expenses. Similarly, the books for the businesses were inadequately tracked, distinguished, and recorded. Nor did the defendant follow required corporate formalities. No bylaws, corporate minutes book, or shareholder ledger were produced for the corporation. Nor was there documentation of shareholder meetings. The only formality that had been followed by the corporation since 2001 was the filing of the biennial report. That report was often filed after the deadline, and the corporation was administratively reinstated three times. The court stated that while the lack of corporate formalities was not sufficient on its own to disregard the corporate entity, it added weight to the other supporting factors.
It is tempting for business owners, particularly those running solely owned businesses, to become sloppy with paperwork or finances. They may believe that because the money all belongs to them, there’s no problem with blurring the lines. This case demonstrates that corporate protections are only available to businesses that follow the laws establishing the protection. Owners wanting to protect their liability shield must keep business and personal finances separate. This also means separate books for all businesses. And, the law means what it says. Owners must follow corporate formalities, including holding shareholder meetings, filing required reports, and keeping corporate minute books. While LLCs require fewer formalities, this case would likely have had the same result if the corporation was an LLC. The surest way to lose liability protection is to commingle business and personal finances, both by paying personal expenses from business accounts and by failing to keep separate books.
CALT does not provide legal advice. Any information provided on this website is not intended to be a substitute for legal services from a competent professional. CALT's work is supported by fee-based seminars and generous private gifts. Any opinions, findings, conclusions or recommendations expressed in the material contained on this website do not necessarily reflect the views of Iowa State University.