Most business owners, including myself, choose to use a business entity through which to do business. One of the main reasons to use a business entity is limited liability. What is limited liability? Limited liability means that the owners of the business are liable for the debts and obligations of the business only to the extent of their investment. In other words if you own $10,000 in stock in a corporation and the corporation cannot pay off its debts, you, the shareholder, will only lose the $10,000 investment you made in purchasing the shares in the corporation. Creditors will not be able to go after your personal assets like your home or car. However, there are exceptions to limited liability in which a business may lose its limited liability or limited liability is circumvented by statute. Limited liability, however, does not protect a business owner from criminal liability or tax liability.
Does My Business Entity Provide Me with Limited Liability?
It depends on the entity you select when you form your business because not all business entities provide limited liability. The corporation, limited liability company or LLC, limited liability partnership or LLP, limited partnership or LP, and limited liability limited partnership or LLLP all provide limited liability. The sole proprietorship and general partnership do not provide limited liability. And in the limited partnership, the general partner will not be shielded by limited liability.
Piecing the Veil of Limited Liability.
Limited liability is not absolute. A business can be held personally liable when courts decide to pierce the veil of limited liability. However, Minnesota has a high barrier to overcome before a court will pierce the veil of limited liability. The Minnesota Supreme Court has laid out the two prong test for piercing the veil in Victoria Elevator Co. v. Meriden Grain Co., 282 N.W.2d 509 (Minn. 1979).
The first prong is whether the entity is merely an alter ego of the business owner. In the alter ego prong of the Victoria Elevator test, a court will consider eight factors:
- Insufficient capitalization for purposes of corporate undertaking
- Failure to observe corporate formalities
- Nonpayment of dividends
- Insolvency of debtor corporation at time of transaction in question
- Siphoning of funds by dominant shareholder
- Nonfunctioning of other officers and directors
- Absence of corporate records
- Existence of corporation as merely facade for individual dealings
Not all factors need to be present for a court to find the first prong satisfied.
The second prong of the Victoria Elevator test is injustice or fundamental unfairness prong. The court must find that it would be unfair or unjust not to impose personal liability on the business owner. Essentially, the business owner would benefit unfairly from limited liability.