What Does Limited Liability Mean?
If you’re an entrepreneur, you’ve almost certainly heard the phrase “limited liability” before, but do you know what all it entails? Are you familiar with the relationship between limited liability and the corporate veil?
While limited liability is a rather simple concept, its application can sometimes be rather complex. If you own a limited liability company, or if you’re considering starting an LLC, it’s important to understand the way the corporate veil applies to your business.
In this article, we’ll discuss the details of limited liability and how it ties into the corporate veil. By the time you’re done reading, we’re confident that you’ll understand how these concepts affect your business.
What Is Limited Liability?
Limited liability means that as a business owner, your liability is limited to the investments you’ve made into your business. If you own a corporation or an LLC, your business provides you with limited liability protection. For example, if your business is sued, your personal assets as an owner ― including your house, car, personal bank accounts, etc. ― are protected, and your creditors are only allowed to pursue your business assets.
How Do You Lose Limited Liability Protection?
Another name for your company’s limited liability protection is the “corporate veil.” Sometimes, you can lose this limited liability protection if your corporate veil is “pierced,” which means that your personal asset protection is revoked by the courts. In this situation, your personal possessions and finances are fair game to your business creditors, and they are free to pursue any of your assets.
If your company is sued, the courts will take a look at your business structure to determine whether your limited liability status should be upheld. There are a few different factors that go into piercing your corporate veil, starting with the interpretation that your business is not separate from you as its owner. This issue is more common with single-member LLCs than with multi-member LLCs or corporations.
How Does This Problem Arise?
Most frequently, this determination comes from the commingling of business and personal assets. For example, if you pay personal bills like your mortgage or car payment using your business bank account or credit card, a judge could determine that your business is an extension of you as its owner.
Another factor that could lead to you losing your limited liability protections is if your business commits fraud or other wrongful actions. One scenario where this could happen is if you borrow money beyond your company’s means, or make deals that your business doesn’t have the funds to honor. These types of acts indicate that you as the company’s owner are making decisions without even considering whether your business can pay an invoice or honor a contract.
The final factor for having your corporate veil pierced is if your business causes unfair damages to another company. This could mean that you make poor business decisions that result in a creditor being left with bills they cannot pay, or it could mean that a company you do business with has court settlements they can’t afford as a result of your company’s misdeeds.
Keep in mind that your business needs to violate all three of the preceding rules to have your corporate veil pierced and therefore lose your limited liability protection.
How Can I Maintain My Limited Liability Status?
Fortunately, there are steps you can take to protect your limited liability status, and keep your corporate veil intact, in addition to simply not doing the things we discussed in the last section. If you keep these bits of information in mind, you should be able to maintain your limited liability.
First off, it’s vitally important that you form your business correctly. Follow your state’s rules and regulations to the letter, and if there’s any doubt, hire an attorney or an online business services company to form your business for you.
Next, it’s equally crucial that you maintain your business according to the guidelines set by your state. You’ll need to file your annual reports in a timely manner, and also keep up with any ongoing maintenance fees charged by your state government.
You’ll also need to sign documents and contracts on behalf of your business, not as yourself. If you simply sign your own name without denoting that you’re signing the document as a representative of your company, a creditor could accuse your business of being a mere extension of you as a person.
Finally, keep a close eye on your company’s finances. You need to adequately capitalize your business, meaning that there should be no point in the history of your company when it doesn’t have the funds to sustain itself. You also need to keep your business and personal assets strictly separated, and keep detailed records of every transaction you make as a business owner.
What Isn’t Covered By Limited Liability?
Your limited liability protection isn’t an umbrella protecting every aspect of your business, as there are some ways creditors could pursue your personal assets even if your corporate veil isn’t pierced. For instance, your business taxes are not protected by the corporate veil, so if you fall behind in your tax payments, creditors (like the IRS) are free to pursue your personal assets.
Additionally, there are some personal acts you can take that are outside the realm of limited liability. These include the issuing of personal guarantees, which in essence waives your limited liability protection with that creditor, and reckless personal acts, like causing a car accident while conducting company business.
Limited liability and the corporate veil are complex topics that affect businesses in many different ways. It’s incredibly important to maintain this protection, or you could face some extremely stiff personal penalties as a result of your business dealings.
If you follow the advice in this guide, you should be able to keep your limited liability intact, and enjoy the protections that come with LLC formation. We wish you the best of luck in your business future!