Traps for the Unwary: Preserving Limited Liability

December 19, 2012

pic-owner-chartsUnfortunately, operating a business in America today involves navigating a legal minefield. Unexpected legal liability or expensive litigation can ensnare businesses that do not know the law. And the law can be absurdly complex and counter-intuitive.

Corporate shareholders and limited liability companies (LLCs) members (i.e. LLC owners) are not personally liable for the debts and other liabilities of the company.  Courts will, however, sometimes ignore this protection and hold owners personally liable for the debts, acts or omissions of a company if the proper formalities are not paid attention to.  This personal liability can potentially be ruinous for the owners of a small firm.  Ignoring the limited liability usually afforded by the corporation or limited liability company is called “piercing the corporate veil.”

Each state is a little different about when owners may be personally liable for company liabilities.  But certain basic themes are common.  Corporations and LLCs have a separate legal existence.  If you blur that separateness, there is a risk that a court will not treat the liabilities of the company as separate.  Thus, you should maintain a separate company bank account.  Personal expenses should not be paid out of this company account.  Company business should be done in the name of the company.  Payments should be made to the company not the owner personally.  And so on.

There is, however, a second set of formalities that should to be adhered to. All corporations have Articles of Incorporation and most corporations have a Board of Directors. Corporations have By-Laws. With LLCs, the Operating Agreement of the LLC governs rather than By-Laws. LLCs may or may not have a Board. The bottom line is that compliance with the corporation’s own Articles and By-Laws can prove critical to establishing its separate legal identity and preserving limited liability. Shareholder meetings and Board meetings need to actually occur as required by the Articles and By-Laws. A written record of those meetings and of the decisions made needs to be maintained (these are called minutes). Similarly, formalities required by a LLC Operating Agreement need to actually occur. There are ways to accomplish this result without actually meeting if permitted by the By-Laws or Operating Agreement.  This would include permitting meetings by teleconference or through unanimous consent documents signed separately.

The bottom line is that even though it seems bureaucratic, complying with these relatively simple corporate formalities may end up protecting you from potentially catastrophic liability if you lose a major lawsuit or your company falls on hard times.

Please click here to read Traps for the Unwary #1: Arrest Records & Employment.

Please click here to read Traps for the Unwary #2: Social Media Policies.

Please click here to read Traps for the Unwary #3: Selling Stock in your Company.

For questions, please contact NSBA General Counsel David R. Burton at DBurton@nsba.biz.

NSBA cannot give legal advice with respect to specific situations.