Millions of business owners have started or converted a business to an LLC or Corporation to obtain protection from business liabilities and debt. This is a solid financial move. But it’s not bulletproof. The Corporate wall of liability protection can and does crumble. You need to know how and why.
There are some not so typical situations where shareholders, members, owners, and even managers can be held personally liable for their business’s debts and liabilities.
4 Ways the Corporate Shield Fails
1) Fraudulent or Illegal Transactions
If a member of an LLC uses the company to defraud or scam folks out of their money then the corporate veil can certainly be pierced. Think of this as “unauthorized corporate transactions”. It is assumed that corporate entities are not suppose to make fraudulent deals. Thus if an owner uses the company for such a deal this action was unauthorized in a sense. The courts will find such a person responsible for such an action personally liable for the damages.
You have to pay your taxes. The same is true for a corporation. If a corporation doesn’t pay its state or federal taxes then the owners will be hunted down for those debts.
3) Intentional Negligence
If you make a decision on behalf of a corporation that harms people and it is clear that you knew of the high probability of such an outcome then you can be held personally liable. For instance if you work at an amusement park and the chief mechanic says this roller coaster will most likely lead to certain injuries and then decide to run it anyways then you can be held personally liable for such a decision and the damages that resulted.
4) Personal Guarantees
More often than not when a new business starts up and takes a bank loan the bank will have the owner agree to be personally liable for the debt. this is the same concept as co-signing on your kids car loan. If the kid doesn’t pay… you will.
Obviously as a business owner who is seeking liability protection through the corporate veil you will want to do all you can to protect this corporate shield. Here are some key principles and actions you can incorporate to your business decision making process.
Protecting the Corporate Veil – 5 Key Business Principles and Actions
1) Start on Smart and Sound Financial Grounds
It’s important to start the corporation with adequate financial resources. There should be an initial cushion to cover operating expenses. 6 months to year would be fine for most. Some business could get away with even less. Others may need considerably more. It just depends on the nature of the venture.
Please don’t misunderstand me, I’m not saying you have to invest a fortune right from the get go. You just need to consider how it will look in front of a Judge. You don’t want to leave wiggle room for the creditor’s lawyers to convince a Judge that you were acting irresponsibly with the business finances from the start. If that happened you would most likely be held liable for at least a portion if not all the debts and financial judgements.
2) Your Business Isn’t You – Keep it Separate
Once those articles of incorporation were filed with the State your business became a separate entity. In fact the federal government views your business as it’s own “person”. This means you need to treat it that way as well. Probably the best analogy of a healthy relationship between the corporate owner and the corporation is the relationship you might have with an important and valuable employee. In this sense you have intimate knowledge of their day to day life, treat them fairly, and expect a lot out of them. What you don’t do is go get a joint checking account. Nor pay for your family’s groceries with their credit card.
The point here is to stay financially separate. The corporation has it’s own bank account, credit cards, vehicles, property, etc.
If you start to blur the lines then you rip the seim of the corporate veil.
3) No Fraud – Use Solid Sales Policies – Do Business Fairly
Doing business legally and fairly is absolutely crucial to protecting the liability shield. The biggest issue I run into are the various sales departments. Some industries are worst than others. But it can be tempting for any sales person to fib at certain moments in their career. It’s important that you as the owner have a zero tolerance policy for fraudulent behavior of any sort. Again pay close attention the sales people you have hired.
4) Transparent Financials When Applicable
If you are in a situation with clients, other businesses, partners, creditors, or especially the IRS it is mandatory that you represent your financials accurately and not mislead others making decisions based on the financial information you gave them. If you grease the reality of the situation to make it fit the likings of your creditors or business partners then you have also just committed big time fraud.
5) Record Corporate Decisions and Actions
This sounds silly to a lot of folks but it is important that you keep accurate records of the corporation.
What kind of Records?
Records of Minutes, articles of incorporation, charters, employee agreements and policies, basically all major corporate decisions and actions.
Where to Go from Here?
This finance blog is a great place for business help resources. If you haven’t started your business yet make sure you leave no rock unturned. Do your research and make an informed decision.