Arm Yourself if You Are Incorporated

Physician's Money Digest, March15 2004, Volume 11, Issue 5

If you own any business entities (eg,your medical practice), you face aserious liability threat you probablydon't know about. Fortunately, it's athreat you can control. And with the helpof an interesting new company, it's athreat you can essentially eliminate.

The liability threat is called "piercingthe corporate veil." If you operate yourpractice as a corporation or limited liabilitycompany (LLC), your business has aso-called corporate veil. This legal termrefers to the liability shield that separatesthe business from you personally.Corporate veil protection is the primaryreason most people incorporate. Withoutit, you would be personally liable for allyour business debts.

Vulnerable Veil

"Piercing the corporate veil" meansthat a court officially ignores the existenceof the corporation and sets it aside.This could potentially happen any timeyou are sued, whether by a private individualor government agency like theIRS. When your corporate veil is pierced,creditors are allowed to come after yourpersonal assets. It's the most litigatedissue in corporate law, and it's not a prettypicture when your personal assets aretossed up for grabs.

I visited a company recently that helpsprevent this from happening. Utah-basedCompliance Management & Insight Inc(CMI; 801-415-0055; www.bulletproofveil.com), offers a service aptly named the"bulletproof veil." This is a corporategovernance and compliance managementservice for privately held companies.More than 80% of their customers arehealth care practitioners, each of whomhas enrolled a business entity for management.When you enroll, a team of attorneys,paralegals, and customer supportspecialists helps you manage your corporateveil to make sure you're protectedfrom veil piercing.

Planned Protection

Courts will only pierce corporate veilswhen business owners have ignored therules and requirements of corporate governance.Unfortunately, there are a lot ofdifferent rules, and medical practice ownershave no idea what they are. Your veilcould be pierced because you didn't holdproper shareholder or director meetingsor did not properly document corporateactions. Businesses have been piercedbecause owners ignored rules they personallywrote into bylaws or operating agreementswhen forming the business. A frequentpitfall occurs when people pay personalexpenses out of a corporate checkbook,or vice versa. In short, there are alot of different paths to veil piercing.

Plaintiffs' attorneys love veil piercingbecause it puts them in a position ofpower and control. "When I'm advising aclient about litigation, one of the firstthings I look for is veil piercing opportunities,because it immediately puts theother side into panic mode," says oneattorney, who not surprisingly asked notto be named. "If you're suing a doctor,and you can't pierce their veil, then I wantto see your law license, because peoplenever bother to keep the rules." Veil piercingvulnerabilities are used to try to forcequick and favorable (for the other side)settlements. "When somebody's personalassets are on the line, the last thing theywant to do is go to court. They'd ratherjust open their checkbooks and push tokeep the settlement terms private."

Those dealing with the bulletproofveil refer to veil piercing as a "stealth"problem. "We have never had a customerwho was correctly maintaining their corporateveil before coming to us," saysRees Jensen, CMI's CEO. "Typically, peoplehave either ignored the issue orassumed their attorney or CPA was takingcare of it. Except, of course, those whohave suffered a prior veil piercing event—they are painfully aware of veil piercingand the need to do something about it."

Some good news:

If you keep therules, the law is on your side. According toattorney Stanford Graham, one of CMI'sfounders and currently its chief legalcounsel, "There is actually a bias in thelaw in favor of protecting a corporation'sveil. If you can demonstrate an adequaterecord of corporate compliance, or inother words, that you have respected thestatus of your corporation as a separatelegal entity, then the courts should, too."

Doctors Beware

There is another side to veil piercingfor medical professionals. In response toa national liability picture that the AMAdescribes as a crisis, many physicians aretaking active steps to preserve theirestates from attack. Frequently this includescreating LLCs, corporations, orlimited partnerships to own and protectpersonal assets.

"Forming business entities for estateplanning and asset protection is a fundamentallysound strategy," Graham says."Clearly, though, the same corporategovernance rules apply. The IRS isaggressively pursuing individuals whouse business entities for asset protectionwithout following proper protocols."Recently the tax court has issued somelandmark rulings showing that if youdon't maintain bona fide business structures,the IRS can and will charge hugeestate, income, and gift tax penalties.

Charles Clawson, CPA, an attorney inLas Vegas, Nev, explains, "The number onerule to follow in asset-protection companies,like LLCs, is strictly following corporateformalities. You have to be a formallyorganized company. Never intermingleor integrate personal stuff with thecompany." Merely using a corporatecheck to buy personal groceries couldexpose the assets of the company andallow a court to question its legitimacy.

To maintain corporate formalities, followthe law to the letter and seek professionaladvice when you're uncertain.

Clark Gardner has lectured to hundredsof business groups in theUnited States and Canada and is aconsultant to high-net-worth individualson retirement, tax, and estateplanning strategies. He welcomesquestions or comments at 888-707-8322 orhelp@infodirect.com. Physician's Money Digestreaders can obtain information on a special 20%discount practice management package for corporateveil protection by calling 888-468-4015.