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FAQ: Business Organizations and Transactions

What are the possible consequences of personal liability for business debts and obligations?

Personal liability for business debts and obligations depends on the selection of business entity and can vary greatly. Personal liability for business debts and obligations can arise where a business loses a lawsuit or incurs a debt obligation and the creditor then goes after the personal assets and property of the business owners or members. Certain business entity selections protect owners, members or shareholders from personal liability, while others do not.

How does entity selection affect personal liability?

The following table shows how entity selection affects personal liability:

Business Entity

Personal liability?

Formal procedures for business selection?

Sole Proprietorship

Yes.

No.

General Partnership

Yes.

No, although a partnership agreement is a good practice.

C-Corporation

No.

Yes, register with state government.

S-Corporation

Maybe, if corporation is operating at a loss.

Yes, register with state government and file election with IRS.

Limited Liability Company

No.

Yes, register with state government.

Special Entities:

(available only in some states)

Limited Liability Partnership

Yes, for own negligent acts, but not the acts of another partner.

Yes.

Professional Service Corporation

No.

Yes, register with state government.

Limited Partnership

Yes, for general partner(s) only.

Yes, written limited partnership agreement required.

Non-Profit Corporation

No.

Yes, register with state government and receive exemption from IRS.

Can business owners become personally liable in any other way?

Despite business entity selection, business owners, shareholders or members may become personally liable for business debts and obligations if they sign personal guarantees. For instance, business owners may be put in this position to obtain financing for the business from a bank. Once an owner, shareholder or member becomes personally liable for a business debt or obligation, the business's creditors can go after personal assets, such as a house, car or bank account, or obtain liens on property.

Directors, officers or shareholders of corporations and members of limited liability companies can become personally liable for judgments against the corporation or LLC in some cases. Courts may find personal liability after "piercing the corporate veil." This is a theory of liability where a court can find a business owner liable for corporate debts by disregarding corporate status. Courts may do this when business owners form a corporation or LLC and use it to commit bad acts, such as fraud, or when the business appears to be a shell for personal dealings.

How can business owners avoid personal liability from business debts?

Besides selecting a business entity that will protect them from personal liability, such as a corporation or limited liability company, business owners should avoid signing personal guarantees, if it all possible. These business owners should also sign all business documents in the name of the business.

For example, if a member of an LLC signs a contract for a supplier to deliver 100 reams of paper to the business, he or she should do so as a representative of the business, signing "in the name of" the business, so that it is clear in the contract that the member is not signing in a personal capacity. If it is not clear, and the LLC later defaults on payment under the terms of the contract, the supplier could try to obtain payment from the member who signed the contract.

Corporations and LLCs should also maintain corporate formalities, such as separate bank accounts and regular business meetings, to ensure that the corporate status remains intact in the eyes of the state.

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DISCLAIMER: This site and any information contained herein are intended for informational purposes only and should not be construed as legal advice. Seek competent counsel for advice on any legal matter.

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