Maintaining Your Limited Liability Protection
While shareholders and members of LLCs generally are not liable for the business’s debts and liabilities, there are exceptions. When a legal entity is not operated properly and incurs liabilities, creditors may attempt to “pierce the corporate veil” and force shareholders to pay for the company’s debts.
Business owners who opt for the corporation or LLC as their entity of choice usually do so to avoid the unlimited personal liability that comes with a sole proprietorship or general partnership. However, closely-held corporations and smaller LLCs sometimes lack visible separation between the owners and the company, giving creditors grounds to pierce the corporate veil. Other reasons include fraud, failure to follow corporate formalities, undercapitalization, self-dealing and other actions that make the business look like the alter ego of the business owners.
Tips on How to Avoid Personal Liability
If you want the liability protection of a corporation or LLC, here are a few useful tips:
- Follow your state’s rules: Each state has its own rules and regulations for corporations and LLCs. Make sure you understand and follow the rules applicable to your entity of choice.
- Hold regular meetings: If you run a corporation, you are required to hold at least annual meetings. While it isn’t a requirement for LLCs, holding regular meetings is a good way to show the world that the business is separate and apart from its owners.
- Keep accurate corporate records: Minutes should accurately reflect decisions of the business and its officers, directors and shareholders. Make sure the right people sign the minutes and any notices or waivers of notices.
- Never mix business with personal: Keep your personal finances and transactions separate from the business’s finances and transactions. If you mix business and personal, you are inviting creditors to get their hands on your personal assets. Business expenses should be paid for by the business. Personal expenses should be paid for the individual. Avoid letting shareholders use business finances for personal bills.
- Do not treat the business as your alter ego: If creditors can prove that the corporation or LLC was simply a façade to gain liability protection, there will be serious legal repercussions. Avoid actions that suggest the business is your alter ego.
- Avoid signing personal guarantees: You might be asked to sign a personal guarantee, perhaps when leasing office space or at a bank when borrowing money. When you sign a personal guarantee, you are agreeing that the liability protection of the corporation does not apply to you. You can’t always avoid signing a personal guarantee. If you must sign it, make sure you are prepared to accept personal responsibility for the agreement.