Avoid Corporation & LLC Personal Liability!

 

Once you have organized your business, you are still not entirely immune from personal liability. When courts impose liability on individuals for the actions of the corporation, this is referred to in legal parlance as “piercing the corporate veil.” In order to avoid personal liability for debts and other acts of the corporation (or LLC) you must run your business entity as a truly distinct and separate entity from the personal affairs of each owner.

A member of an LLC or shareholder of a corporation can be held personally liable for many different types of claims, but they typically arise under these different scenarios:

  • Claims arising out of an act or omission by the owner directly, such as the owner’s own negligence, fraud, illegal act or violation of a fiduciary duty;
  • Claims arising out of a contract, particularly one that was personally guaranteed by the member;
  • Liability for unpaid employment taxes, wages, worker’s compensation insurance and unemployment contributions;
  • Claims based on the concept of “piercing the veil” of the LLC;
  • Liability for consenting to or receiving a distribution in violation of the LLC’s operating agreement or the applicable LLC statute;

These claims are not a result of choosing an LLC over a corporation, or vice versa. All of these exceptions apply equally to shareholders in corporations and members of LLC’s. But, there are many exceptions to the rule of limited liability. Many members or shareholders will find that, due to the way the business was operated, the promised protection from the liabilities and claims of the business is not meaningful.

 

With that in mind, here are 14 steps every business owner should follow to help minimize or eliminate personal liability.

 

1. Provide adequate capital for the business’s intended purposes and document all capital contributions by proper company resolution. This includes corporations and LLC’s;

2. Corporations should always issue stock and keep records on the appropriate stock ledgers and I also recommend that LLC’s issue membership certificates to evidence ownership;

3. At a minimum, prepare annual minutes for meetings of shareholders and directors and minutes for any special meeting called by the shareholders or directors.  I also strongly urge you to adopt resolutions reflecting approval of all major corporate actions, as identified in the Corporate Resolutions Section. LLC’s should also take steps to document some of the more significant actions highlighted above and should also make a habit of preparing company minutes;

4. Provide written notices of the annual or special meetings of the shareholders and directors, or consents in lieu of proper notice strictly according to the requirements and procedures set forth in the Bylaws and keep those notices in your corporate book;

5. Members of an LLC should always draft resolutions documenting, among other significant actions, all capital contributions, real property and other asset and equipment purchases/sales, admittance of new members, appointment of managers or key employees, entering into significant joint ventures and strategic partnerships, entering into all significant loans and other indebtedness, amendments to the Operating Agreement, and all other actions requiring unanimous consent of the Members under the Operating Agreement (i.e. major actions);

6. Corporations should pay dividends to its shareholders when possible;

7. Do not elect other directors and officers who serve no operational purpose. You need to involve directors and officers and any managers of an LLC directly with the management of the business and affairs of the corporation or LLC;

8. Always maintain a separate identity from the owner(s). For instance, use separate letterhead, use the full, legal name of the business (unless you have filed for an assumed name) and always market the business under the full legal name or any legally authorized assumed name. Do not use the same or similar name or logo for related companies;

9. Keep a separate bank account for the business funds and never commingle business and personal funds;

10. Maintain arm’s length transactions. An ‘arm’s length’ transaction is a transaction between two otherwise unrelated or un-affiliated parties, or is a transaction between two related or affiliated parties that is conducted as if they were unrelated, in a manner where no reasonable conflict of interest can exist;

11. Do not divert assets, meaning corporate assets should always remain corporate assets and not transferred to any owner (or relative or affiliate of any owner). If the business looks like it is going down, don’t attempt to lessen your own loss by taking big draws or moving assets out of the LLC. That will only help open the floodgates to your personal assets;

12. Carry Business insurance! Carrying adequate business insurance won’t change the fact that you are personally liable for your own negligence, but it can help by providing a source for payment to cover any judgments obtained against you personally. You might also consider a personal umbrella policy;

13. If you can help it, avoid signing personal guarantees. Not all personal guarantees can be avoided but do not simply consent to every guarantee automatically. In many cases, vendors routinely request personal guarantees even where they shouldn’t. You should not grant this request, or at least raise it as an issue;

14. Do not favor one creditor over another or make a distribution to one creditor over other creditors holding outstanding company debt during a period of insolvency or dissolution. LLC Acts typically prohibit an LLC from making certain distributions. For example, the final draft of the Revised Uniform Limited Liability Company Act provides that a limited liability company may not make a distribution if after the distribution: (1) the company would not be able to pay its debts as they become due in the ordinary course of the limited liability company’s activities; or (2) the company’s total assets would be less than the sum of its total liabilities plus the amount that would be needed, if the company were to be dissolved, wound up, and terminated at the time of the distribution, to satisfy the preferential rights upon dissolution, winding up, and termination of members whose preferential rights are superior to those of persons receiving the distribution. A member of a member-managed limited liability company or manager of a manager-managed limited liability company who consents to an improper distribution is personally liable to the company for the amount of the distribution which is improper. Also, the person who knowingly receives a distribution that it is in violation of the Act is usually personally liable for the portion of the distribution that is improper. Note: Using available funds to pay other creditors when the business is unable to pay the employment taxes is an indication of willfulness.

While no guarantee can ever be made regarding the potential for personal liability, following these basic guidelines will place you in a much better position to withstand liability. Not following one or more of the above steps does not automatically subject business owners to personal liability. But, these are all factors most courts use to evaluate in the aggregate whether the corporation is really an “alter ego” of the owner(s) and thus whether the corporate veil should be pierced.