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
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.