Keeping Your Corporate Veil Strong
Many of our clients in the fuel distribution business operate as part of a larger, integrated group of distinct businesses. For example, the overall group of companies may include a fuel distribution business, a retail gas and convenience store, trucking, home heating oil or propane business. Often, these clients find it beneficial, for a number of reasons, to organize each business within its own legal entity, with the group of businesses typically connected through common ownership and control and several key contractual arrangements.
One of the most common arrangements is to establish a holding company, owned by the owners of the business enterprise. This can be set up as a corporation, limited liability company or partnership, depending on the particular ownership, tax and other considerations. We find that LLCs and corporations are the most commonly-used vehicles. Beneath the holding company, each business unit is organized in a separate legal entity (again, typically an LLC or a corporation), and each of these entities would be wholly-owned by the holding company. In some cases, tax and other corporate motivations can result in the organizational structure having multiple levels, but there is most commonly a single entity at the top of the structure.
An important goal of a structure like this is usually to isolate the potential risks and liabilities of each business to that business unit itself, rather than exposing the entire enterprise to the risks of one particular business operation. While some details will vary from state to state, and each case is dependent upon its own facts and circumstances, the law generally upholds the “limitation of liability” feature of corporations, limited liability companies and similar legal entities. This means that liabilities and obligations of such entities remain with the entity, and do not extend to the owners, officers and directors. In a more complex organizational structure with multiple entities, the goal is to insulate each from the liabilities of the other. For example, an incident that occurs in the trucking business might expose the company to material liability (e.g. a product spill, an accident causing death, etc…), but a properly established and maintained organizational structure could keep the liability and exposure from that incident with the trucking company, while sheltering the retail business, the fuel distribution business and others in the structure which are owned by separate entities.
When we are helping clients establish such a structure and manage operations in a way designed to maintain the liability shield described above, there are several factors that we take into consideration. Some of these factors fall into a general category of “corporate formalities”, which means we ensure that each entity in the structure has a board of directors or governors, that each board elects officers or managers, and that annual or other periodic board meetings are scheduled to conduct the business of each entity. We advise such clients that each entity should maintain separate bank accounts and books and records, and that any “sharing” of funds between entities should be carefully documented and described (e.g. intercompany loans should be reflected as such on the books of each entity involved in the same). The general principle is that the “separateness” of each entity should be reflected in the daily operations and in the corporate books and records for each entity in the structure.
Although maintaining “separateness” is of critical importance, there are practical business operational concerns that can be addressed by contractual arrangements. For example, it could be unwieldy and expensive for each entity in this type of structure to handle its own administrative matters, including functions such as accounting, insurance and human resources. In these situations, we often help our clients create administrative services or similar agreements, so that these types of functions can be performed by one entity (often the holding company) for all of the entities in the structure. So long as these agreements apportion costs and expenses among the entities on a reasonable basis, they can allow for greater efficiency, while not undermining the goal of shielding the entities from their respective liabilities. In addition to these agreements, we also recommend that entities within the structure that are doing business with one another (e.g. the fuel distribution company supplying the gas and c-store company) do so under written agreements that are on customary industry terms and conditions.
There is no guaranty that any particular organizational structure will survive any and all challenges to pierce the corporate veil. However, establishing and maintaining an entity structure that respects the separateness of the entities in the structure, and putting in place agreements among the companies for any shared services or inter-company transactions, can provide strong arguments that the liability of any one or more entities in the structure should stay with those entities. Of course, we always recommend that companies seek sound legal, tax and accounting advice in creating these structures, as each situation can present unique goals and issues.