One of the main reasons to set up your business as a corporation or limited liability company (LLC) is to shield your personal assets from debts and other liabilities incurred by your business. Corporations and LLCs exist as separate legal entities from their owners, allowing the business to acquire assets, enter into contracts, and take on debt.
In turn, if your business cannot pay its debts, creditors can go after your company’s assets, not your personal ones. However, there are several circumstances in which a business owner can be held personally liable for the debts of a business, and you need to understand how these potential pitfalls can leave you at risk and vulnerable.
Sometimes, business owners make innocent mistakes when running their businesses, leaving them personally liable. Other times, when business owners take specific improper actions, such as using the corporation to promote fraud, failing to observe corporate formalities, or even just inadvertently commingling business and personal assets, a court can hold the owners personally liable for the debts and liabilities of the business. When this happens, it’s known as “piercing the corporate veil” to reach the personal assets of the owners of a business.
If you’re thinking of incorporating your business or already own a corporation or LLC, you should become familiar with the following scenarios that can leave you personally on the hook for your business liabilities.
Do Not Commingle Business & Personal Finances
When running a small business, the most considerable risk to your business (and your personal assets) is commingling your finances with your business. It can be as benign as using a company bank account to pay your mortgage or depositing a check made out to your business into your personal account. If you are doing this now, there’s no shame in it, but there could be a significant risk to you.
Commingling your business and personal finances means that if you are ever in a lawsuit related to your business and a judgment is obtained against your business, a court can order that you’re using your company as an extension of yourself. Therefore, you should be held personally liable for your business’ debts. In that case, everything you’ve read or believed about your business entity protecting your personal assets just goes right out the window, and you lose all the protections of having set up a business entity to separate you from your business. On top of that, commingling business and personal finances mean you will not be able to make wise strategic decisions based on the financials of your business, and that’s your most significant risk, bar none.
Commingling your business and personal finances means that if you are ever in a lawsuit related to your business and a judgment is obtained against your business, a court can order that you’re using your company as an extension of yourself. Therefore, you should be held personally liable for your business’ debts. In that case, everything you’ve read or believed about your business entity protecting your personal assets just goes right out the window, and you lose all the protections of having set up a business entity to separate you from your business.Michele Hyndman
When we work together with you on an ongoing basis providing strategic counsel, we will regularly review your company’s financials with you and your bookkeeper to ensure you’re keeping all of your business finances and personal finances separate in the exact way required to protect your personal assets.
Do Not Personally Guarantee Business Debts
If you cosign a business loan or personally guarantee a financial obligation for your corporation or LLC, you share responsibility with the company for paying it back. And if your business defaults on a loan you’ve personally guaranteed, your company’s creditors will come after your personal assets, even if you have a business entity in place. And they’ll be able to reach your personal assets to pay back your business debts.
Do Not Use Personal Assets As Collateral
Since many small business owners don’t have much startup capital, you may be asked to use your personal property, such as your home or other assets, as collateral on a business loan. If so, the personal assets you pledged as collateral can be seized and sold off to pay your company’s creditors if your company fails to repay the loan. Only pledge personal assets as collateral for business debts if you have no other choice but to do so to obtain funding.
Do Not Commit Fraud
If you make fraudulent representations or omissions to secure a business loan, you can be held personally liable for those debts. Similarly, suppose your corporation or LLC was created to further a fraudulent purpose, or you made business deals knowing the company couldn’t pay for them. In that case, you can be convicted of fraud, thereby voiding your personal liability protection. Or, if you fraudulently transfer assets to protect your assets when you know there is an outstanding risk of a judgment against you, you can be held liable for the judgment under the laws of fraudulent transfer. Bottom line: don’t commit fraud. If you aren’t sure if an action would be considered fraud, talk to us first.
Do Follow Corporate Formalities
To maintain their status as a separate entity, corporations are legally required to follow certain administrative formalities and observe specific rules. If you fail to treat your business like a corporate entity by not abiding by these formalities—such as keeping detailed records (minutes) of meetings where vital business decisions are made or adopting corporate bylaws—the court can determine your company is nothing but a shell and remove the veil of protection shielding your personal assets.
Maintaining corporate formalities is among the most critical actions needed to keep you safe from business creditors. Most small business owners simply don’t do this because it’s the last thing on their priority list. As your Family Business Lawyer® with business planning expertise, we will prioritize you with our corporate maintenance packages and systems specifically designed to help you abide by these formalities and keep your personal assets secure.
Keep Your Veil Intact
In light of all of the complexities surrounding corporations and LLCs, you should meet with us, your Family Business Lawyer® with business planning expertise, to protect your personal assets from your business activities. We will not only help you decide which business entity structure is best suited for your operation. We’ll also assist you in properly setting up and maintaining the entity, so your personal assets are always well protected. Call us today at 754-253-8825 to get started.
This article is a service of Michele Hyndman, your Family Business Lawyer™. We offer a complete spectrum of legal services for businesses and can help you make the wisest choices on how to deal with your business throughout life and in the event of your death. We also offer a LIFT Start-Up Session™ or a LIFT Audit for an ongoing business, which includes a review of all the legal, financial, and tax systems you need for your business. Schedule a LIFT Planning Session or call us today at 754-253-8825 to schedule.