This post focuses on personal liability that individuals may face as business owners of corporations and/or limited liability companies (“Businesses”). Liability may be imposed even though certain business entities, by their type and nature, are designed to protect the owners from business debts and liabilities. By taking certain precautions, however, owners may be able to avoid being held personally liable for acts and activities of the Business.
This will be a multi-post blog entry. This first post discusses some types of business entities that are designed to shield business owners from business debts and liabilities.
Post 1 – What Entity Types Afford Protection
Typically, most Businesses, regardless of whether they are manufacturers or service providers, are formed as an LLC or a corporation.
Corporations: One of the advantages of forming a corporation is that, when formed, a corporation is an independent legal entity separate from its owners (i.e., shareholders). That is, the corporation can own assets in its own name and be held accountable for business debts (e.g., to banks, financial institutions), contractual obligations (e.g., to suppliers or customers), or other liabilities. Shareholders are the owners of the corporation and generally not liable for business debts. A corporation can sue and be sued in a court of law in its own name. If a bank files a claim against a corporation, it will have to go after the corporation’s assets and properties and cannot generally sue shareholders or make a claim against their assets (except in limited circumstances).
LLCs: An LLC is like a corporation formed as a separate legal entity. Owners of the LLC possess membership interests and are called “members” (much like shareholders of a corporation). Members are generally not liable for debts and obligations of the LLC. Further, like a corporation, an LLC can sue and be sued in its own name. Creditors can generally make claims only against the LLC’s properties and assets, and not against the members. Unlike a corporation, however, an LLC is a “pass-through” entity for tax purposes, unless they elect otherwise. This means that all of the profits and losses of the LLC “pass through” the business to the members, who report these profits on their personal tax returns. The LLC itself does not pay federal income taxes, though some states impose an annual tax on LLCs.
Partnerships: General partnerships, on the other hand, do not afford separate legal entity status to their partners. This makes each of the general partners jointly and severally liable. That is, all partners are jointly (i.e., together with other partners) as well as severally (i.e., individually) liable for the aggregate debts of the partnership business, unless they form a limited liability partnership.
While liability of business owners is generally limited in the case of a corporation or an LLC, simply by forming an entity that has separate legal entity status may not necessarily ensure protection for business owners against Business debts and liabilities. It is imperative that owners understand aspects of the business early on that have the potential to expose them to personal liability. They can then adopt appropriate safeguards to avoid such liabilities and adequately protect their personal assets.
Our next post will focus on circumstances where the court may implicate business owners, even though they may be shielded by a corporation or LLC’s separate legal status.
This posting is intended to be a planning tool to familiarize readers with some of the high-level issues discussed herein. This is not meant to be a comprehensive discussion and additional details should be discussed with your transaction planners including attorneys, accountants, consultants, bankers and other business planners who can provide advice for your circumstances. This article should not be treated as legal advice to any person or entity.
About the Author
R. Shawn McBride – R. Shawn McBride is the Managing Member of The R. Shawn McBride Law Office, P.L.L.C. which helps clients in legal issues related to starting companies, joint ventures, raising capital from and negotiating with investors and outside General Counsel functions. Shawn can be contacted at: (214) 418-0258; firstname.lastname@example.org, or www.mcbrideattorneys.com.
Saurabh Nathany – Saurabh Nathany is a Paralegal at The R. Shawn McBride Law Office, P.L.L.C. Saurabh can be contacted at: (312) 394-9924, or email@example.com.