Respecting the Corporate Form for Marijuana Businesses

One of the main reasons we recommend our business-owning clients incorporate their business or form an LLC is for the personal asset protections these business models provide. However, in my years of practice, I have witnessed an alarming number of clients jeopardize their personal assets by failing to adequately separate their business activities from their personal endeavors.

When this happens, owners risk “piercing the corporate veil” – meaning they risk losing the liability protections that having an LLC or a corporation provides them. If a business’s corporate veil is pierced, a judge may order the owners’ personal assets to be used to satisfy their business’s debts and liabilities. To avoid this unfavorable outcome and maintain your limited liability protections, it is important to abide by the key responsibilities outlined below:

1. Undertake the Necessary Formalities.

Businesses must complete any annual filings required by the state to protect and ensure the longevity of the company. This includes obtaining all applicable permits, licenses, or approvals necessary for legal compliance. All businesses should also create and regularly update their bylaws or operating agreement, and hold annual meetings of the members/shareholders and managers/directors.

2. Avoid Under-Capitalization.

Under-funded businesses have a higher risk of veil piercing because creditors may argue the business exists solely to shield the owners’ assets. Businesses should be equipped with enough resources to both start and continue operations. Funding may come through the owners’ own money, outside investors who become owners, or business loans. Regardless of the method used to accrue capital, the money should be designated to the business, not the owners personally.

3. Maintain a Written Record of Business Decisions.

All business meetings should be documented through meeting minutes, emphasizing any major business decisions reached in the meeting. Additionally, all formal contracts entered into by the company should be signed and kept for at least seven (7) years. These records protect the corporate veil by evidencing the business’s separate existence and operation outside of the owner(s).

4. Do Not Commingle Business and Personal Assets.

Whether arising from loans, shared bank accounts, shared tax returns, or personal use of business assets, failing to separate business assets from personal assets negates the business’s separate identity. All business owners should, at minimum, set up a business checking account and a business credit card, and only use these for business expenses. It is also important to keep business assets, like property and equipment, separate from personal assets. Notably, businesses should not be used as a lender for their owners.

Make Your Business Status Known

Create business cards and email addresses using the business name, and make purchases or receive payments through the business bank account. It should also be made clear when the business, not an individual owner, is acting. When the business enters into an agreement, use the company name and have the owner(s) sign with reference to their corporate designation. By clarifying when the business, not an individual owner, is acting, the corporate veil becomes more resistant to attack.

The most important thing to remember is that there must be a clear distinction between what assets and activities are attributable to the business and which are attributable to the owner(s). If owners cannot prove that the above steps have been followed, it may be determined that the business is operating as a sole proprietorship or general partnership, in which case the owner(s) would lose the limited liability protections inherent in an LLC or a corporation and the corporate veil may be pierced.

Research shows that approximately 50% of “piercing the veil” court cases succeed because business owners fail to follow the corporate formality requirements above. If you have any questions about respecting the corporate veil or what your business can do to ensure it is protected, please let us know.