Business

Essential Guidelines for how business owners may protect their personal assets and avoid personal liability for claims arising from the operation of their business.

1. Utilize a business entity which provides for limited liability of owners and operators.

Persons conducting a business as a sole proprietor or general partnership (i.e., without any corporate entity) have unlimited personal liability for debts and other obligations of the business. A sole proprietorship is a business for which the assets used by the business are owned individually by the proprietor. Likewise, contracts of a sole proprietorship are executed by the proprietor in his individual capacity rather than as agent for a separate business entity. Not only are the sums invested in the sole proprietorship business at risk, but all other assets of the proprietor are subject to claims against the business as well. For example, if the business is found liable for breach of a contract with a customer, a judgment will likely be entered against the owner for personal liability, subject to satisfaction from both assets used in the business as well as any of his or her other non-exempt assets. Also, partners in a general partnership are each jointly and severally liable for all debts of the partnership. Unlike a limited partnership, all partners in a general partnership have full liability. Absent agreement to the contrary, each partner of a general partnership has authority to contract on behalf of the partnership.

By contrast, owners doing business as corporations, limited liability companies or limited partnerships are generally not personally liable for the debts, obligations or liabilities of the business, including liabilities under a court judgment, decree or order.  If properly formed, the business is a separate legal entity with all the powers of a natural person. Only assets owned by the business are subject to execution to satisfy a judgment for debt or liability of the entity.  The business owns only assets needed for successful operations. The business entity must be formed in accordance with state law and all required filing fees must be paid.

2. Adequately capitalize the business.

No business should commence operation without capital sufficient to sustain operations, meet liabilities and provide a reserve for contingencies. In order to do so, the entity must at a minimum collect the initial capital contributions pledged to be made by shareholders of a corporation, members of a limited liability company or partners of a limited partnership. Copies of checks, wire transfers or other means of payment should be retained as proof of such contributions. Secondly, in the event of depletion of initial capital or increased expenses or liabilities, the entity may need to secure additional capital to continue or expand operations and meet financial obligations. Additional capital may be raised from new investors or further contributions from existing owners.

If a business operates without adequate capitalization, the business owners and operators could later be held personally liable for claims against the business. An entity which lacks adequate capitalization to pay claims may be considered merely an “alter ego” for the individual owners or operators. The business entity is viewed as merely a sham to protect the owners from their wrongful or negligent conduct. Collection of capital contributions pledged by owners (shareholders of a corporation, members of an LLC or partners in a partnership) counters such allegations.

3. Avoid commingling of business and personal assets.

• Consider hiring an accountant to track business and personal assets, to keep your cash flow statements up-to-date, and to keep your business operating on an enforceable budget.
• Maintain separate bank accounts. It is essential that funds paid or received on behalf of the business be segregated from personal funds. A separate bank account is therefore required.
• Keep timely and accurate records of all transactions between business owners and the business, including loan advances and prepayments, capital contributions whether in the form of cash, donated property or services rendered. Properly authorize and document corporate transactions affecting the capital structure of the business. If additional funds are received after commencement of business, document the nature of the consideration received, i.e. sale of an interest in the company, loans, or cancellation of any stock or other interest.

4. Pay all taxes and file required tax reports.

The entity must pay all franchise, payroll and federal income taxes and must file all required tax reports on a timely basis. State law requires franchise tax reports and public information reports to be filed even when the business entity is inactive or no tax is due.

5. Maintain adequate insurance coverage.

Even following the above guidelines, proper insurance coverage is still a must. Doing business by means of a business entity only protects the owners from claims arising out of contracts of the business. A business owner, operator or employee is still liable for his or her personal negligent conduct that causes injury to third parties. Moreover, the business may in turn be held liable for that conduct if committed in the scope of employment.

Last Modified: December 5th, 2009