Limited liability shields shareholders of corporations and members of limited liability companies from personal liability for company debts. The companies and their owners are treated as distinct legal entities, each responsible for only their own debts.
Limited liability, however, is not limitless. There are exceptions.
In some circumstances, courts will “pierce the veil” of your entity, destroying the shield of limited liability. Observing certain formalities demonstrates to creditors and courts the distinction between your company and its owners—showing that your company is a legitimate business separate and apart from you. To protect yourself before creditors seek to hold you personally liable for company debts, follow our suggestions below.
Adequately Capitalize—or Fund—Your Company. Companies have bills to pay. When yours has enough money to meet its regular obligations, courts are more likely to see it as a separate entity and less likely to see your company as just a shell created to protect you from liability. Courts measure adequate capitalization at the time you form your company, and companies may become undercapitalized later for many legitimate reasons. It’s smart to keep sufficient funds to pay company bills because business owners may be found personally liable if they withdraw amounts from the business that render it insolvent.
Maintain Separate Bank Accounts. Always keep your and your spouse’s personal assets separate from the company’s by maintaining separate bank accounts. Handle all official business through the company account and never commingle company and personal monies. Remember, moreover, that while distributing dividends and paying salaries from the company’s account is perfectly fine, never directly withdraw from the company’s account for personal purposes and do not charge personal expenses on a company credit card. Lastly, any deposits of your personal funds to the company should be documented as a loan to avoid commingling.
Keep Your Personal Affairs Separate from Your Company. Know when you’re acting as an individual as opposed to a representative of your business, and make sure clients, customers and creditors know too. Be sure to use your exact legal company name when conducting business with third parties. Further, when signing a contract, loan application, or vendor or credit agreement, always write your official company title, not just your name, to make it clear that you are signing in your official capacity, not personally. And be sure to always include the entity designation “Inc.” or “LLC.”
Keep at Arm’s Length. Ensure that courts see a distinction between you and your business by keeping at arm’s length during all transactions. To do this, when conducting transactions between the company and its owners, observe the same formalities and create the same documentation you would for a third-party business deal.
Keep Your Companies Separate from Each Other. When you own multiple companies, to prevent one company from becoming liable for the debts of another company you must keep each company’s affairs separate from your other companies. Treat each company as a separate and distinct entity and conduct all transactions between your businesses at arm’s length. Never commingle company funds, do not pay one company’s bills from another company’s account (unless it’s documented as a loan), keep separate records and be clear about which company you represent in any dealings with clients, customers and creditors.
Observe Corporate Formalities. Make sure your company looks like a real business. Corporations should issue stock, adopt company bylaws, elect officers and board members, hold annual meetings, keep annual minutes and maintain company books and records. These formalities may seem trivial when you’re running a small operation, but observing them makes a big difference in the eyes of a court. While LLCs are not required to follow many formalities by law, it is important to observe at least a few to maintain limited liability status. Every LLC needs a clear operating agreement along with well-maintained company books and records. LLCs should also hold formal meetings and keep minutes when making important business decisions such as changes in ownership.
Find out how to maintain the appropriate degree of separation between your personal interests and those of your business by contacting us at (312) 216-2720 or info@marcusboxerman.com.