Whether you are just starting a new venture or growing your business beyond a sole proprietorship, you will inevitably reach a point where you want to ensure that your personal assets will not be vulnerable in the event that lawsuits or other liabilities confront your business. In the world of small business, there are two clear vehicles to accomplish that goal: a limited liability company (LLC) or an S-corporation (often shortened to S-corp).
Both LLCs and S-corps do what sole proprietorships do not, and that is remove your personal assets from the reach of your business creditors. Many small business owners often choose to form LLCs because of the perception that there are fewer corporate “formalities” then there are for corporations. While that is largely true, LLC owners who fail to maintain and treat the LLC as a separate entity expose themselves to the very personal liability for corporate obligations that led them to form the entity in the first place.
“Piercing the Corporate Veil”
“Piercing the corporate veil” is the term used when creditors are able to reach beyond the protections provided by the entity and impose personal liability on the business owners for the liabilities of the company. Mississippi courts have applied the same standards for piercing the veil of corporations to piercing the veil of an LLC.
As the Mississippi Court of Appeals explained in a 2012 decision:
“While an LLC is a different type of legal entity than a corporation, commentators agree that for purposes of piercing the corporate veil, an LLC would be treated like a corporation. Section 37-29-305(1) of the Mississippi Limited Liability Company Act provides that an LLC member cannot be individually liable for an LLCs debt by reason of being a member. Thus, to pierce the veil of an LLC the complaining party must prove LLC membership as well as some frustration of contractual expectations, flagrant disregard of LLC formalities by the LLC members, and fraud or misfeasance by the LLC member.”
Restaurant of Hattiesburg, LLC v. Hotel & Restaurant Supply, Inc., 84 So.3d 32 (Miss App. 2012)
A court will apply a three prong test to determine whether an LLC’s veil can be pierced and personal liability imposed on some or all of its members. In addition to proving that the defendant is in fact a member of the LLC, a plaintiff seeking to pierce the veil needs to prove:
(a) some frustration of contractual expectations,
(b) flagrant disregard of LLC formalities by the LLC members, and
(c) fraud or misfeasance by the LLC member.”
It is the second prong of this test in particular that tends to put LLC owners at risk. Especially in single member LLCs or LLCs with very few members, it can be tempting to disregard certain formalities in the name of convenience, even if there is no intent to defraud or otherwise engage in any impropriety. But if you are an LLC owner in Mississippi, it is critical that you understand that the protections afforded to your assets aren’t set in stone just because you formed an LLC. Unless you conduct your business in a way that makes clear that the LLC is in fact a separate business, creditors and others may be able to “pierce the corporate veil” and leave you and your personal assets exposed to significant liability.