5 Steps to Limiting Personal Liability in Business
The LLC and corporation are popular business entities because they limit the owner’s personal liability for actions taken on behalf of the business – but they don’t just magically erase that liability. Rather, these entities require regular attention to maintain the owner’s liability protection.
Too often, business owners – and individuals using these entities for personal asset protection – neglect their all-important, ongoing obligation to maintain them. Some fail to pay their taxes, others forget to update their corporate minutes and charters to reflect business changes, and many allow their business assets to become commingled with their personal ones.
When this happens, the owner makes it easy for creditors and litigants making claims against the business to pierce the corporate veil and attack the personal assets the entity is specifically designed to protect.
Why pay for an LLC or corporation only to neglect it? There are more efficient ways to waste money.
Maintaining Your Limited Liability
At any given time, an owner must be able to show that the business exists as a legitimately separate entity. To do ensure your liability remains limited, take the following steps:
1. Complete necessary formalities.
Corporations have strict rules they must follow, and while LLCs do not face the same stringent requirements, many of the same steps are advisable.
Corporation: Create and regularly update bylaws, issue shares of stock to owners (shareholders) and maintain a stock transfer ledger, hold initial and annual meetings of both directors and shareholders, undertake annual filings required by the state in which the entity was incorporated in a timely manner and pay the necessary filing fees, and pay corporate taxes.
LLC: Undertake any annual filings required by the state in which the entity was incorporated in a timely manner and pay the necessary filing fees. I further recommend creating and regularly updating an operating agreement, issuing membership certificates to owners, keeping a membership transfer ledger, and holding both initial and annual meetings of the members (and managers, if your LLC is manager-managed).
2. Document your business actions.
Everything you just did in step 1 is useless if you can’t prove you did it. This is why you need to document the major business decisions and meetings you hold. Appoint a secretary who’s role is to keep minutes at such meetings. Furthermore, you should always have copies of the contracts to which your company is beholden.
Document that you held the initial and annual meetings of directors and shareholders (corporations) or members/managers (LLCs) and keep the meeting minutes from each of these meetings. Keep formal business documents for at least seven years.
3. Keep the business and personal assets separate.
Under no circumstances should you use personal accounts for business expenses or business accounts for personal. This shouldn’t be hard but many owners forget, to their own peril when a claim is presented. Commingling funds is one of the easiest ways to undermine the liability protection provided by your entity.
The same rule applies to other assets like equipment and real property.
4. Fund your business – not yourself.
Money makes the world go ’round – well, the business world at least. Regardless of whether you fund your business through by reaching into your own pockets, those of your investors, or those of a bank, you need to ensure the capital is designated to your business and not to you. Otherwise, you’re inviting a world of financial and legal hurt.
5. Make your corporate or LLC status known.
Order business cards, letterhead, or custom pens – anything a company would brand with their with their name and logo. Apart from simply being good marketing, such objects help reassure your business’ legitimacy.
More importantly, though, conduct all the actual business in the name of the company. Ensure that you make purchases and pay invoices via a business checking account or credit card. Create invoices in the company name to send to your clients. Sign leases and appropriate documents in the name of the company.
Remember: If a judge cannot distinguish between what belongs to the business and what belongs to the owner – and the owner cannot prove the rules have been followed – the judge may determine the company effectively less like a corporation or LLC and more like a sole proprietorship or general partnership – entities that lack the same liability limitations. At that point, the corporate veil is easily pierced and your personal assets easily awarded to any plaintiff.
Good luck and good hunting.
The Fisher Law Office is known for its experience in estate planning, probate administration, asset protection, and business development. Annapolis attorney Randall D. Fisher has practiced for over 20 years, maintains the highest peer review rating for ethics (AV Preeminent) by Martindale-Hubbell, and is a sucker for long walks on the fairways.