One compelling reason that influences business owners to either incorporate or form a limited liability company under which to conduct their business operations is the desire to limit personal liability for the debts and other obligations of their business. Typically, a shareholder is not liable for the debts of the business. In most instances, the most that a shareholder will lose in an unsuccessful business venture is the shareholder’s initial capital contribution and the shareholder’s time. This insulation from personal liability is what encourages entrepreneurs and sole proprietors to form limited liability entities under which to operate the business.
Unfortunately, many business owners fail to recognize that a business owner and shareholders may, in certain circumstances be held liable for the debts of the business.
This liability arises when the corporate veil is pierced. The corporate veil may be pierced when a business is sued for a debt or tort or some other obligation. As part of the lawsuit, the plaintiff may allege that the company did not operate as legal entity separate and apart from the officers, directors and shareholders such that the company was actually the alter ego of the shareholders, officers and directors and not a separate legal entity. As such, the plaintiff argues that these individuals should be held liable individually for these business debts and obligations.
When the corporate veil is pierced, the personal assets of the company’s officers, directors, and shareholders become available for the plaintiff’s damages, thus defeating the whole purpose of forming a corporate entity. Here are some steps you should take to protect yourself, as a shareholder, from becoming liable for the debts of your business.
First and foremost, operate your business like a business. Do not pay for personal expenses out of your business. Do not pay business expenses personally. In other words, the business pays its bills and you pay your bills – do not commingle your personal affairs with the operations of your business.
Second, memorialize major decisions by the business with minutes approving these transactions. Typically, a business should memorialize with corporate minutes all real estate purchases or sales and leases as well as major purchases of equipment and vehicles. Minutes should also be prepared regarding the issuance of shares of the company’s stock, the election of directors, appointment of officers, and approving employment contracts. At a minimum, annual meetings of directors should be held as well as an annual shareholder/member meeting. These meetings may also be memorialized with written unanimous consents of directors. The bylaws or operating agreement should provide guidance as to the requirements for the annual meeting of shareholders or members.
Third, the business should follow and maintain accurate and complete financial records as well as filing all required tax returns. Following these basic rules will help to insure that your limited liability entity is treated as separate and distinct from you individually thus providing you insulation from business liability such as debts. Failing to do so your personal financial security as risk.