Avoiding Personal Liability as a Business Owner
Choosing the proper form for your business can make an important difference in protecting your personal assets.
Although there are many reasons a prospective owner should consider in
choosing the legal form of his or her business, among the most important
is limiting the owner’s personal liability for actions of the business.
In two common situations business owners are, by default, personally
liable: when an individual operates a business as a sole
proprietor, or when two or more individuals operate a business as a
general partnership. In either case, the owners have unlimited
personal liability for the obligations and wrongful acts of the
This exposure can be quite hazardous to the owners’
personal fortunes. For example, if an employee of a sole proprietor
injures another person while performing his or her employment duties,
the owner is liable for that injury. As another example, if one
general partner incurs a large debt on behalf of the partnership, all
partners are liable for repayment. For reasons such as
these, most business owners form a business entity to limit their
The most popular limited liability business entities
are corporations and limited liability companies. For both of
these entities, absent extraordinary circumstances, the owners are not
personally liable for the acts or debts of the business.
In addition to protecting the owners, both
corporations and limited liability companies also provide additional
protection for those who manage the business.
In the case of corporations, this means the directors
and the officers regardless of whether they are also owning
shareholders. When a director or officer is sued because of his or
her status as a director or officer, the corporation must indemnify him
or her for the acts he or she took on behalf of the company so long as
she was acting in good faith and in the best interest of the business.
In other words, the corporation must pay for expenses and losses
incurred in defending the lawsuit.
In the case of limited liability companies, those
responsible for management are called managers, who are frequently, but
not necessarily, also the owners. When a member or manager is sued
because of his status as a member or manager, the limited liability
company must indemnify him or her in a manner substantially the same as
As with all things legal, there are of course some
exceptions to the limited liability shield of business entities:
• An owner’s personal investment of capital into the
business is at-risk with no guarantee of its return. If that
investment is necessary to settle a lawsuit claim or pay a debt, the
owner cannot get it back. However, the owner is not required to
invest more to cover a claim. With limits, owners may reduce their
at-risk capital by loaning money to their own business instead of
investing it directly.
• If business owners do not run the business properly,
a court may order a “piercing of the veil” such that the owners are
personally liable for claims against the business. Factors that
may lead to “piercing the veil” are failure to follow the record-keeping
and report-filing requirements of the business and, especially,
commingling business and personal assets and debts.
• If the business provides a professional service,
such as law, medicine, or accounting, there is no liability shield for
the professional malpractice of the licensed business owner.
• If a creditor requires an owner to sign a personal
guaranty for a business debt, as lenders almost always do, the owner is
personally liable for repayment of that debt.
These exceptions notwithstanding, with some careful
planning and management, owners can rest a bit easier on the risks they
face as owners by significantly reducing their personal liability
exposure simply by operating as a corporation or limited liability
company. Owners should continue to use other risk reduction techniques
such as maintaining all desirable insurance coverages.
Finally, business owners need to consider many other
factors when choosing a business entity besides the limitation of
liability discussed in this article. Among those factors are tax
treatment of the entity, management structure, restrictions on transfer
of ownership interests, capital structure, formation costs, requirements
for record-keeping and administrative formalities, and many
others. For these reasons, owners should consult their legal,
accounting, and financial advisors when forming or re-forming their
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