One of the primary reasons business owners set up corporations and limited liability companies (LLC) is to shield their personal assets from debts and other liabilities incurred by the business. Below, you'll learn how your innocent mistakes will remove LLC protection.
Indeed, corporations and LLCs exist as separate legal entities from their owners, meaning the business itself can acquire assets, enter into contracts, and take on debt. In turn, if a corporate entity is unable to pay its debts, creditors are typically only allowed to go after the company’s assets, not the owners’ personal assets.
However, there are several circumstances whereby business owners can be held personally liable for corporate or LLC debts. Sometimes, business owners simply make innocent mistakes when running a business that leave them personally liable.
Other times, when business owners take certain actions, such as using the corporation to promote fraud, failing to observe corporate formalities, or even just inadvertently commingling corporate and personal assets, a court can hold the owners personally liable for the debts and liabilities of the corporate entity. When this happens, it’s known as “piercing the corporate veil.”
If you’re a business owner who’s thinking of incorporating, or if you already own a corporation or LLC, be aware of the following considerations, which can leave you personally on the hook for business debts.
Sign up to be liable
If you cosign on a business loan or personally guarantee a financial obligation for the corporation or LLC, you share responsibility with the company for paying it back, and creditors can come after your personal assets if the business defaults on the loan.
Use personal assets as collateral
Since many small business owners don’t have a lot of startup capital, you may be asked to use personal property, such as your home or other assets, as collateral on a business loan. If so, the personal property you pledged as collateral can be seized and sold off to pay your company’s creditors.
If you make fraudulent representations or omissions to secure a business loan for your company, you can be held personally liable for those debts. What’s more, if your corporation or LLC was created to further a fraudulent purpose or you made business deals knowing the company wasn’t able to pay for them, you can be convicted of fraud, thereby voiding your personal liability protection.
Commingle your business and personal finances
As a small business owner, you may be tempted to commingle your personal finances with those of your company. It can be something as benign as using a company account to pay your mortgage or depositing a check made out to the company into your own account. In doing this, a court can decide that you’re using your company as an extension of yourself, and therefore you should be held personally liable for its debts.
When you’re working with us as your Creative Business Lawyer® on an ongoing basis, we regularly review your financials with you and ensure you’re keeping everything separate in the exact way you need to in order to protect your personal assets.
Fail to follow corporate formalities
Corporations and LLCs are legally required to follow certain formalities and observe certain rules. If you fail to treat the business like a corporate entity by not observing these formalities—such as keeping detailed records (minutes) of meetings where important business decisions are made and adopting corporate bylaws—the court can rule your company is nothing but a shell and remove the veil of corporate protection covering your personal assets.
Indeed, maintaining corporate formalities is the single-most important aspect of keeping you safe from business creditors. When you’re working with us, we offer maintenance packages to help you with this and keep your personal assets safe.
Given all of the complexities surrounding corporations and LLCs, you should consult with us to make sure you’re not opening yourself up to be personally liable for your business debts. We can not only help you decide which business entity structure is best suited for your situation, we can also help you properly set up and maintain that entity, so your personal assets are protected.
We offer a complete spectrum of legal services for businesses and can help you make the wisest choices on how to deal with your business throughout life and in the event of your death. We also offer a LIFT Start-Up Session™ or a LIFT Audit for an ongoing business, which includes a review of all the legal, financial, and tax systems you need for your business. Call us today to schedule. Or, schedule online.