A limited liability company is a shield for your personal assets, a shelter in the storm of lawsuits or other legal disputes. It draws the all-important boundaries between your personal and business lives. But how, exactly does it accomplish this?
It’s all because of the “LL” in “LLC” – limited liability. You’ve likely encountered the acronym before. Maybe you even run your own limited liability company, and you’ve been running it for years. But have you ever stopped to consider what “limited liability” means in the context of your business? 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 complicated. If you own a limited liability company, or if you’re starting an LLC, it’s important to understand the way the corporate veil applies to your business.
Quick Note: If you haven’t yet created an LLC and would like help, ZenBusiness and LegalZoom are both very popular services that can take care of the paperwork for you.
What Is Limited Liability?
The LLC name doesn’t exactly explain how your liability is limited, and this might give you pause. Limited to what? In short, it means that the only personal assets that are liable are the ones you’ve invested in the company or labeled as a company resource.
Picture this: your business is sued and from among all the anxieties associated with a lawsuit comes a question – will I lose my house? My car? My savings? If you’ve formed a limited liability company correctly, the answer is no on all accounts. This is because an LLC distinguishes your business as separate from you as an individual, so if your company is sued, creditors can only pursue the company’s assets, not your personal ones.
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 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 would be fair game to your business’ creditors.
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.
Your corporate veil can be pierced for a number of different reasons, but the most common is if the court deems the business is not actually separate from you as the owner. Most often, this issue is confined to single-member LLCs, but it can affect multi-member LLCs and corporations as well.
How Does This Problem Arise?
Keep your personal and business assets separate and you’ll avoid this issue altogether. But if you intertwine them and crossover between them, you could be in trouble. 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 the business is simply an extension of its owner.
Or, your limited liability could be at risk if your business commits fraud or other wrongful actions. Say you borrow money beyond your company’s means or make deals that your business doesn’t have the funds to honor. In these cases, you as the company’s owner are making irresponsible or downright malicious decisions without considering whether your business can pay an invoice or honor a contract.
You know the rule about treating others the same way you’d like to be treated? It applies here too. Your corporate veil could also be at risk if you cause unfair damages to another company. For example, a company you do business with could have court settlements they can’t afford as a result of your misdeeds. To be fair, this isn’t always a result of malicious acts. Maybe you just made some poor business decisions and now you can’t pay a creditor what your company owes.
This isn’t “one and done” though. 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?
The good news is that you don’t need to sit around worrying if you might accidentally lose your limited liability status. You have the power and means to maintain it! Along with avoiding the things we discussed in the last section, there are practical steps you can take to protect your status. If you keep these bits of information in mind, you should be able to keep that corporate veil whole and intact.
First and foremost, 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 a business incorporation service to form your LLC for you. This will properly establish your company as a separate business entity and grant you limited liability.
It’s equally crucial, however, that you maintain your business according to the guidelines set by your state. Does your state require annual reports? Make sure to file them on time. Do you need licenses or permits? Don’t forget to renew them when necessary. This will keep your LLC in good standing with the state.
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 as a representative of your company, a creditor could accuse your business of being a mere extension of you as a person. Always be careful not to let your business and personal lives commingle.
Finally, keep a close eye on your company’s finances. Ensure that you maintain the funds necessary to sustain the business and pay any debts – you could cause unfair damage to another business if you can’t pay them what you owe. 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. This way, you’ll be able to prove that the business is truly distinct from you.
What Isn’t Covered By Limited Liability?
Your limited liability protection isn’t an umbrella that shelters every aspect of your business. There are still some ways that creditors could pursue your personal assets without piercing your corporate veil. 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.
These aspects aren’t confined to business actions, your personal actions can be hazardous to limited liability too. This includes issuing 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.
There’s no denying that limited liability and the corporate veil are complex topics, ones that manifest in various ways for different businesses. But one thing is for sure: maintaining this protection is incredibly important. You certainly want to avoid the severe personal penalties that can arise from business dealings.
Of course, this isn’t meant to scare you. Many LLCs never have an issue with their corporate veil protection. And yours won’t either, as long as you carefully follow the guidelines listed here. Do this, and the only thing you’ll have to worry about is growing your business, then watching it thrive.