Co-Mingling

April 13, 2006

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Co-mingling of assets involves the owner using business resources for personal purposes, or the business using the owner's personal resources for business purposes. Co-mingling is also a primary basis upon which courts apply the alter ego theory when a creditor seeks to pierce the veil of limited liability. When the rules regarding separation and documentation are followed, co-mingling of assets should not occur.

Especially in the case of the small business owner, co-mingling can occur in other instances, because assets and expenses can have mixed (part business, part personal) uses. Ultimately, adequate documentation of the business purpose of a transaction can ensure that no co-mingling will occur.

In one case, a court refused to pierce the veil of a corporation, even though the owner had used corporate funds to pay what appeared to be personal expenses, including travel, dry cleaning, telephone, and even housing expenses of the owner.

The court found that these expenses could be considered legitimate business expenses. The court based this conclusion on the fact that the owner meticulously maintained separate corporate records and accounts that clearly identified the business purpose of the expenditures. Thus, no co-mingling of business and personal resources occurred, as the expenses paid by the business were business expenses and not personal expenses of the owner.

In contrast, this same court did pierce the veil of a corporation where the corporation paid unauthorized salary advances and unauthorized loan payments on the owner's personal car. Here, the lack of records and authorizations meant that the expenses were not legitimate business expenses, but instead personal expenses of the owner. Thus, co-mingling (paying personal expenses from business resources) occurred.

The small business owner should be aware of a fact pattern that afflicts many small business owners, one that can prove fatal from an asset protection perspective. Many times, there will be insufficient cash available in the business's accounts to pay the business's bills, or in the owner's personal accounts to pay the owner's personal bills. Be aware that this is the situation most likely to result in a co-mingling of resources.

Unfortunately, it is also likely that, in this situation, the business will be experiencing financial difficulties. This makes it more likely that the business will undergo scrutiny from creditors who are not being paid. This scrutiny may take the form of a lawsuit, wherein the creditors attempt to prove that the alter ego theory should be applied to the owner and the entity.

A business entity should never directly pay what are clearly personal expenses of the owner.

Let's say a business owner needs a new roof on his personal residence, which will cost $4,000, but the owner does not have sufficient funds in his personal accounts to cover this cost. He does, however, have sufficient funds in his business entity's accounts. This cost cannot be justified as a business expense, at least if the owner conducts his operations outside of the home.

It would be a mistake to have the entity issue a check on the business account payable to the roofing company. This would represent a co-mingling of resources and could open the owner to a piercing of the veil argument.

Instead, the entity should authorize, in writing, and then pay the owner a salary, pursuant to a written salary agreement between the owner and the entity. A check from the business account would be issued to the owner, and recorded on the entity's books as salary expense. The owner would deposit the check in his personal account and then write a personal check to the roofer.

This ensures that the required separateness exists. It is advisable to pay an amount of salary that does not exactly match the owner's personal expense. It also is advisable to pay salary on a regular basis. Following these two strategies can prevent a court from "collapsing" the separate transactions into a single transaction, wherein the court would conclude that the business paid the owner's personal expenses. Note, too, that regular payments from the entity to the owner for leases and loaned assets also accomplish the same goal as a payment of salary.

Similarly, the business owner should never personally pay what are clearly business expenses from his personal accounts.

Say the business entity's telephone bill, for $400, is due, but this business lacks the required funds in its accounts to pay the bill. It would be a mistake for the owner to pay this bill with a personal check or credit card. Instead, the owner could lend the cash to the entity, under a written loan agreement. It is not necessary that a new loan agreement be executed each time. Instead, an open-end agreement can be used. The entity could use the loaned funds to pay the bill directly from its business checking account.