by Nick Gromicko, CMI® and the InterNACHI® Legal Team
We encourage every home inspector to form a corporation or limited liability company (LLC) for his or her inspection business. The reason for this is that in Western legal systems, corporations and LLCs are treated as entities that are separate and distinct from their owners. Therefore, the owners of an entity are not personally liable for the debts of the entity.
This limited liability is an inherent purpose for incorporation; however, this protection is not absolute. Employing a remedy known as “piercing the corporate veil,” a court may disregard the separateness of a corporation or LLC when failure to do so would bring about an injustice.
Typically, courts will not allow the corporate veil to be pierced except in certain factual circumstances. Courts consider a variety of factors to determine whether the corporate form should be disregarded, including:
- whether the corporation is operated as a separate entity;
- commingling of funds and other assets;
- the failure to maintain adequate corporate records;
- the nature of the corporation's ownership and control;
- the absence of corporate assets and under-capitalization;
- the use of the corporation as a mere shell;
- disregard of legal formalities; and
- diversion of the corporation's funds or assets for non-corporate uses.
Generally, if an entity looks like it is not the alter ego of its owner(s), the courts will treat it as a separate entity. While every case is different, there are steps an inspector may take to reduce the risk that a court might pierce the corporate veil of the inspector’s business entity. The following strategies are recommended:
- Obtain a separate Employer Identification Number (also known as an “EIN” or Taxpayer ID number) from the IRS. Corporations are required to do this, but LLCs with a single owner are not because a single-member LLC owner may use his or her Social Security Number. Nevertheless, we recommend that single-member LLCs obtain their own separate EIN.
- Open a separate bank account for your corporation or LLC.
- Do NOT mix personal money and business money.
- Do NOT pay personal expenses from a business account.
- Do NOT pay business expenses from a personal account.
- File the required annual report with the Secretary of State in your jurisdiction.
- File required tax returns for your business.
- Title business property in the name of the entity.
- File business property tax returns if required by your state.
- Prepare minutes of meetings of shareholders and directors (for corporations), and minutes for annual meetings of members (for LLCs).
- If the corporation or LLC has more than one owner, make sure there are written bylaws (for a corporation) or a written operating agreement (for an LLC).
- Keep licenses and insurance in the name of the entity.
- Make sure the public knows your business is a corporation or LLC. If a customer knows he or she is doing business with a corporation or LLC and voluntarily chooses to do so, the customer is not in a good position to ask a court to pierce the corporate veil. On the other hand, if the customer has no knowledge of the existence of a separate entity, a court may determine that equity requires it to pierce the corporate veil. Therefore, the wise inspector puts the public on notice by including “Inc.” or “LLC” on the inspector’s website, advertisements, forms, and business cards.
- Make certain that when you sign your pre-inspection agreement or other legal documents, it is clear that you are signing as a representative of your LLC or corporation rather than in your own individual capacity. For example,
XYZ Inspections, Inc.
John Smith, President
If you think this is all just abstract legal theory, you might read the opinion of the Indiana Court of Appeals in ABC Home & Real Estate Inspection, Inc. v. Plummer, 500 N.E.2d 1257 (Indiana App. 1987). In that case, the inspector’s corporation never issued stock, the inspector advertised himself as the “owner” of the business, and the inspector kept his contractor’s license in his name rather than in the corporation’s name, so the trial court determined that the inspector’s corporation was a “sham” and was the mere “alter ego” of the inspector. The inspector appealed, but the Indiana Court of Appeals determined that the trial court properly pierced the corporate veil, and the inspector was personally liable to the home buyers.