Owning a business can be an exciting prospect, but if not organized and run properly, you may become personally liable for business related expenses. No business owner ever wants to think about the possibility of being sued for unpaid business debts or losses caused by their employees, but it can happen. Below are a few ways to avoid personal liability should your business be part of a litigation.
Structuring your Business
The first step to avoid personal liability is to make sure the business is structured properly. If you are currently operating your business as a sole proprietorship, the law considers you and your business the same entity. So, what does that mean? It means you are liable for your business debts, and most if not all your personal assets can be considered for collection to pay all the debt owed. Conversely, operating your business as a Corporation or an LLC prevents business owners from being personally liable for things related to business. The law assumes you and the business are separate legal entities. Therefore, you have no personal liability for the debts of the business (assuming no Personal Guarantees are in place), even if the business can’t pay them.
Once your business is structured, it’s important to maintain corporate compliance. This will ensure that all business owners are protected. It’s critical to make sure your Corporation or LLC have been set-up properly, documents have been completed timely, annual meeting minutes have been prepared, and any outstanding compliance issues have been addressed.
Personal vs Business
When operating your business, it’s important to be aware of situations that might put your personal protection at risk. Never comingle personal assets and debts with business debts. Do not use personal credit cards to make purchases on behalf of the Company. Do not sign a personal guarantee for a business loan. These scenarios will subject you to being personally liable for those debts.
While it may seem inconsequential, another way to expose your personal assets is by signing a business contract or agreement with your personal name versus signing on behalf of the company. Mary Jones, CEO of 123 Inc. should sign any documents related to the business as “Mary Jones, CEO.” If she were to simply sign as “Mary Jones” she may have opened herself up to be personally liable for that debt.
Misrepresentation, Inadequate Legal Separation, Poor Records
Any misrepresentation or untruths stated when applying for a loan or credit on behalf of the corporation or LLC may cause you to be personally liable for the debt. In addition, if you fail to maintain a formal legal separation between the business’s finances and your own personal finances, creditors can try to hold you personally responsible. Another way for creditors to come after personal assets is if the formalities imposed on corporations and LLC’s by the State were not followed. Examples of this would be paying a business bill out of your personal bank account or making a corporate decision on your own without documenting them in minutes of a meeting. It’s important to note that even businesses owned by an individual or a married couple must obey these rules and formalities.
In closing, when starting and running a business, it’s important to take the necessary steps to limit personal liability. If you have questions or concerns regarding your business or would like assistance setting up and maintaining your business entity, our firm can help!