Individual vs Corporate Liability
Many businesspeople and entrepreneurs start their companies as formal business entities for one primary reason: the limited liability of a company. Many members of the general public have heard the term “limited liability” or “limited liability company.” However, the distinction between the liability of a corporation and individual liability is often misunderstood.
Types of Liability
Limited liability of a company does not mean that a company owner or shareholder can never be liable. It only means that – so long as (i) the corporate form is respected, (ii) the company is adequately capitalized, and (iii) the company does not function as its owner(s)’ “alter ego” – shareholders are not to be responsible for the liabilities of the company merely by virtue of being shareholders. Thus, a company owner who causes a company liability to a third party also remains responsible for that liability in his individual capacity – his status as a shareholder does not relieve him of his individual liability.
In this way, limited liability is only a partial shield. The question of business liability it never absolves an owner of his individual liability for his actions. However, companies often indemnify their employees and officers for acts undertaken in good faith on the company’s behalf.
Limited Liability: Piercing the Corporate Veil
The limited liability protection available through corporations, LLCs, or LLPs is one of the primary reasons why smart business owners establish companies. Limited liability generally protects a business owner’s personal assets from exposure for liabilities of the company. With limited liability protection, a creditor cannot access such assets merely because the owner has a stake in the company. Only the entity’s assets (and those of the directly responsible actors) will normally be subject to claims against the entity.
Avoid Piercing the Corporate Veil
Many business owners do not realize that this protection only applies if certain conditions apply:
- The business owner must not treat the business as his or her “alter ego.” In other words, they must not tap into it as a personal account, nor use company assets for personal use.
- The company must not be under-capitalized. This means it must carry enough insurance or keep sufficient assets to pay reasonably foreseeable obligations.
- The company’s corporate form must be respected. Meaning the agreements you sign on for in the operating agreement are binding. This holds you responsible for performing your duties to the best of your ability as outlined in the contract.
Failing to respect the corporate form, failing to adequately capitalize the company, or treating it as an alter ego can lead to “piercing of the corporate veil” in the event of liability. If that happens, a creditor (including a plaintiff with a judgment) may be able to access the personal assets of the company’s shareholders or members. “Piercing the veil” can also be used to blur the distinction between a parent company and its subsidiaries. If you don’t understand the rules, you could do it on accident. That’s why it’s so important to seek legal advice when setting up your corporate structure and writing up your operating agreement.
Respecting the corporate form means that the company’s officers must comply with certain corporate formalities. These are usually established in bylaws, operating agreements, or statutes. Since you cannot comply with rules that you don’t know exist, it pays to hire a good corporate lawyer to help you draft operating rules that are customized to your business.
We will guide you through the complexities of the law so you’ll know how run your company in a way that minimizes the risk to your personal assets.
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