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Reverse Piercing

Forming a corporate entity such as a Limited Liability Company is a popular planning tool to limit personal liability exposure as it relates to business affairs. Individuals often create corporate entities with the intention of protecting their personal assets from the liabilities associated with operating a business. While this is the proper method to protect personal assets, business owners must be diligent to keep personal matters separate from business matters and avoid co-mingling the two.

Most business owners are familiar with the risks associated with co-mingling personal affairs with their business ventures. The primary risk being that in the event a lawsuit is filed against the business, a court could potentially review the business affairs and rule that there is a lack of separation between using business assets for business purposes versus personal use. “Piercing the Corporate Veil” is the term most commonly used to describe judgments entered due to lack of distinction between personal and business use. If a court rules that an entity’s corporate veil has been pierced, a shareholder can be held personally liable for the debts and obligations of the business.

The consequence that results from a pierced corporate veil is the potential for a court to hold the company’s owners personally liable for the company’s wrongdoing. Once a court pierces the corporate veil, a company’s creditors can attempt to seize the business owner’s home, bank accounts, investments, and other assets to satisfy the debts of the company.

Conversely, how would a court rule in a lawsuit against a business owner personally rather than against the business itself in instances where the same co-mingling has occurred? In other words, would the court allow for a reverse piercing of the corporate veil, thereby allowing an obligee to access assets owned by an entity, essentially treating the entity as though it was never formed?

The Oklahoma Court of Civil Appeals recently ruled that an entity can be held responsible for the liabilities of an individual member or shareholder in cases where a business becomes an “alter-ego” of an individual. Mattingly Law Firm, P.C. v. Henson, 2020 OK CIV APP 19. Put simply, a creditor can attach directly to a business’s assets in the event the individual controlling the business is using the business assets for personal purposes. Importantly, the individual in control of the entity is not required to have ownership in the business.

A court will likely consider a business an “alter-ego” when 1) the LLC is under capitalized; 2) the LLC does not have separate financial records from the business owners’ personal financial records; 3) individual obligations are paid by the LLC or vice versa; or 4) the LLC is a mere sham. Id. at ¶17. Therefore, if the individual who is in control of a business uses business assets for personal purposes (i.e. buying groceries, cash withdrawals, etc.), a creditor may claim an interest in the assets of the business rather than just the shares of the business.

Mattingly sheds additional light on not only the importance of keeping business affairs separate from personal affairs, but also the necessity of accurate record-keeping. Additionally, business owners should be increasingly cognizant of how authorized parties utilize business assets to ensure there is no co-mingling for personal use.