What to Know About Limited Liability As You Grow Your Business

Your Business is Growing,should you be Worried About Limited Liability?

     Starting a business involves a certain amount of inherent risk. While entrepreneurs must be willing to take some risks, there are steps they can take to reduce these potential risks, both to the business and to themselves. When forming a business, entrepreneurs can choose a legal structure with limited liability. By legally separating the business from themselves, owners can at least know that if the company faces financial distress, their individual assets will not be exposed to company liabilities. However, limited liability is not absolute. There are several ways that business owners can be personally liable even when their company provides a liability shield. 

     Limited liability means that business owners and investors can lose only the money they invest in a company. They are not personally liable if their company faces creditor claims due to a lawsuit or debt. Business creditors can reach the company assets an individual has invested in a business, but not the individual’s private assets. Common types of modern business structures that provide limited liability include the limited liability company (LLC), limited liability partnership (LLP), and corporations.

The Limits of Limited Liability

     Although courts are generally hesitant to impose personal liability on a company’s owners, they may do so in some situations, such as the following: 

• The limited liability business entity was not properly formed (e.g., because the appropriate paperwork was not filed with the state, and thus the separate legal entity was not formed).
• A business owner’s or their employee’s negligent or reckless actions cause injury to another person (i.e., the tort exception to limited liability). 
• The owner personally guarantees a business loan on which the company defaults.
• A state or federal statute imposes liability on the owners (e.g., laws related to environmental and tax liability).
• The “veil” is “pierced” because an owner did not maintain the separation between their personal affairs and business affairs, for example, because they commingled personal and business funds.

     The term “piercing the veil” applies not only to corporations, but also to LLCs and LLPs. Typically, courts will not pierce the veil simply because a creditor will not otherwise get paid. Veil piercing requires evidence that the company was somehow used to perpetuate fraud or abuse the limited liability structure. For example, the court may decide that veil piercing is appropriate in the following scenarios:

• A company was knowingly formed with insufficient capital to meet its contractual obligations and normal business functions (undercapitalization).
• The business entity is a mere instrument for transacting the personal affairs of the owners/shareholders/members/partners and serves no legitimate purpose.
• There is evidence of fraudulent activities, such as an owner who siphons business funds.
• A company failed to follow compliance requirements, such as filing an annual report, holding annual meetings, obtaining business licenses, and having a registered agent. 

How to Maintain Limited Liability

     Keeping the limited liability of a corporation, LLC, or LLP intact requires knowing and preventing the circumstances that can eliminate the liability shield. Specifically, owners should understand the following and take the following steps to maintain limited liability: 

• File the appropriate paperwork with the state at the time of business formation. 
• Respect business formalities that make veil piercing less likely. Always hold board and shareholder meetings, pay dividends, and maintain detailed books and records, and avoid commingling personal and company funds to maintain the separateness of the limited liability entity. 

We can help!

Our attorneys can help you with your limited liability planning. For assistance with these and other business law, tax planning, or estate planning matters, contact our office today!

Legal Disclaimer – The information provided is designed for general information only and is not intended to be legal advice, nor does it create an attorney client relationship. Consult an attorney before making any legal decisions based on your individual circumstances.