So your small business is starting to take off, and you’ve decided to take the next step and register your business as a Limited Liability Company (“LLC”) or other limited liability entity. Congratulations! This is obviously a big step for you and your business, and symbolizes a significant milestone that you have reached. However, as an owner of a limited liability entity, it’s important that you understand what it means to have “limited liability” and how to ensure that your business maintains that status.
One of the primary purposes of granting businesses limited liability status is to encourage and provide some space for those businesses to innovate and take risks. After all, you’re putting in a great deal of your own hard work and money to get your business off the ground, which in turn provides opportunities and benefits for you and those that you serve and employ, and the overarching policy of our national framework is to encourage, and not deter, the creation of those opportunities. In order to do that, the limited liability entity provides a legal degree of separation between you and the business to protect you personally from liability in the event that your business becomes exposed. For example, if a party sued your limited liability business for a tort (e.g., an injury that occurred on the business’s premises), then that party’s available recovery would be limited only to the assets of the business, and not you personally.
Your business’s limited liability status, however, does not necessarily mean that you can use it as a vehicle to shield your assets from creditors. To the contrary, courts in Georgia will disregard your business’s limited liability status, and hold you personally liable, if it finds that you were commingling the business’s finances with your own personal finances, your business failed to adhere to corporate formalities, you failed to adequately capitalize your business, or you otherwise used your business to perpetrate fraud and/or injustice. This is what’s typically referred to as “piercing the corporate veil” or “alter-ego liability.”
- Commingling Assets – Courts in Georgia are permitted to pierce the corporate veil of a limited liability business if it finds that the individual owners of the business “commingled their property, business, or their personal affairs with that of the corporations, or that of the corporations with their own.” Farmers Warehouse of Pelham v. Collins, 220 Ga. 141, 149-150 (1964); see also Cobra 4 Enterprises v. Powell-Newman, 336 Ga. App. 609, 613 (2016); Ishak v. Lanier Contractor’s Supply Co., 254 Ga. App. 237 (2002). A primary example of commingling is when a person utilizes a single bank account for themself and their business. In order to maintain your limited liability status, it is important that you keep the finances of your business separate from your own finances. That means that any money flowing out of the business to you must come out through the proper channels (e., as a salary payment or draw of income).
- Adherence to Corporate Formalities – Georgia law requires that businesses adhere to certain formalities in carrying out their operations. Some of these formalities include [1] maintaining a registered office and registered agent in Georgia (for LLC’s, see OCGA § 14-11-209); [2] filing an annual registration with the Secretary of State (for LLC’s, see OCGA § 14-11-1103); [3] holding annual meetings and maintaining corporate minutes (not technically required for LLCs but highly encouraged and often contained in the LLC’s organizational documents; see also OCGA § 14-11-310); and [4] maintaining corporate records (for LLC’s, see OCGA § 14-11-313). If Georgia courts find a gross failure to adhere to required corporate formalities, such finding will authorize them to pierce the corporate veil of a limited liability business. See Christopher v. Sinyard, 313 Ga. App. 866, 867-869 (2012).
- Failure to Adequately Capitalize Business – Businesses in Georgia are required to maintain adequate capital in order to satisfy their debts. However, merely being underfunded will not provide grounds to pierce the corporate veil. “[F]or undercapitalization of a corporation to justify piercing the corporate veil, it must be coupled with evidence of an intent at the time of the capitalization to improperly avoid future debts of the corporation.” Hickman v. Hyzer, 261 Ga. 38, 39-40 (1991). This does not mean that the directors of an adequately capitalized business that later becomes insolvent without ill-intent is free from potential liability; those directors are “bound to manage the remaining assets for the benefit of [the business’s] creditors.” Ware v. Rankin, 97 Ga. App. 837 (1958). Bottom line – it’s best to always have enough money in your business’s bank account to pay the bills that you have or anticipate becoming due in the near future.
- Fraud/Injustice – As a final umbrella rule to alter-ego liability, Georgia Courts are permitted to pierce the corporate veil where the business has “overextended its privileges in the use of the corporate entity to defeat justice, to perpetrate fraud, or to evade statutory, contractual, or tort responsibility.” G & E Constr. v. Rubicon Constr., 357 Ga. App. 55, 58 (2020); see also Kissun v. Humana, Inc., 267 Ga. 419, 421 (1997). Violation of the above-three rules would necessarily include a violation of this rule, but Georgia Courts have allowed this rule to remain open-ended in the event that some other bad faith abuse of the corporate form is discovered. See G & E Constr., 357 Ga. App. at 59-60. This catchall rule is intended to solidify the policy that limited liability businesses in Georgia cannot abuse their limited liability status, and owners of such businesses must remain cognizant in their personal and business dealings of potential pitfalls that can arise under this rule.
In sum, limited liability status, when utilized in the proper manner, is an excellent corporate form that can encourage innovation and risk-taking and lead to market improvements that benefit both businesses and consumers. However, it is important for business owners to take the necessary steps to preserve their limited liability status in order to ensure that such protections don’t end up working against them. Consulting with knowledgeable legal and financial professionals can often help businesses safely operate within the bounds of the law and maximize their potential for the good of the business and its potential clients, employees, and customers.