Many new business owners understand that incorporating or forming a Limited Liability Company (LLC) helps shield a business owner against being held personally responsible for their company’s liabilities and debts. This is known as the corporate shield or corporate veil as it separates your personal assets from those of the business.
Liability protection is not absolute and there are several instances where a business owner can be personally liable in business despite the fact he or she created a business entity.
Here are five of the most common ways this can happen:
1. Negligence and Personal Liability
In many situations, the limited liability protection from an LLC or corporation will not shield you from being liable for your own personal negligence. A person is typically liable for his or her own personal conduct when that conduct injures someone else. For example, if an electrician installs some wiring in a customer’s home and forgets to cap a live wire, the electrician can be personally liable if someone gets electrocuted. Likewise, if you’re driving to a client meeting in a company car and are negligent and hit someone, you can be personally liable for any injuries and damages.
If you make untrue claims about a product or service, this is considered fraud. For example, if you’re marketing a milkshake supplement and guarantee that customers will shed 20 pounds per month just by drinking it, this could be a clear case of misrepresentation or fraud. If you claim that your glass container is BPA-free (when actually it does contain BPA), this also is fraud. In such cases, both the manufacturer as well as the company selling the product may be liable.
3. Personal Guarantee on Business Loans
When you first start your business, many third parties and creditors won’t be willing to do business with your LLC or Corp, as the entity is brand new and probably does not have a lot of assets or hasn’t built its own credit history yet. As a result, a bank or landlord may require the business owner or LLC member to “personally guarantee” a loan or lease. If you sign such an agreement, then you will be personally liable for those specific obligations.
4. “Piercing the Corporate Veil”
Many new business owners form an LLC or Corporation and then continue to operate their business as if that business entity didn’t exist. It’s very important that you follow through with all corporate formalities required for your LLC or corporation. For example:
• Pay your business’ state and federal taxes
• Don’t commingle your personal and business finances
• File your annual report (if required by the state)
• Keep up to date with your corporate minutes and resolutions (if necessary)
• Record any changes with ‘Articles of Amendment’ (if necessary)
• Have a board of directors and hold annual meetings of shareholders (if necessary)
You’ve got to make sure that your corporation or LLC remains in good standing. Why? Because if your business happens to be sued and the plaintiff shows you haven’t maintained your LLC/Inc to the letter of the law, your corporate veil is pierced and you can be personally liable again.
5. Conducting Business Out of State
If you’ll be conducting business in a state other than the state where you formed your corporation or LLC, you will need to obtain authority to do so. In most cases, this entails qualifying as a Foreign Corporation or LLC within the state that you will be doing business. Specific licenses and permits may also be required for certain types of businesses as well.
For example, let’s say you run a small software development company based in Nevada and your company serves clients located outside Nevada. At this point your company is most likely not considered to be operating out of state. However, once you open a small development office with a few employees in California, your business will probably be considered to be doing business in California and you will have to file a Statement and Designation by Foreign Corporation form with California.