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Storming the Castle: Company Owners Can be Liable for Company Debts and Liabilities

Asset protection is a key consideration for business owners and professionals who organize or incorporate their enterprises. The use of a legal entity is helpful, yet it is equally important to fully understand the limits to legal protection afforded by these legal entities.  

One of the primary reasons for forming a business or a professional practice as a Limited Liability Company, Corporation, or some other legal form is to obtain the asset protection that comes with the proper formation and use of these legal entities. The overarching legal principle is that the personal assets of the owners of legal entities will not be subject to the debts, obligations and liabilities of the organization.

That well recognized rule is not, however, the end of the story . . .

Improper Formation

The company or legal entity must be properly formed to gain the desired legal protection. After the entity is formed, it must be properly maintained with the state authorities. Failure to observe these requirements can lead to personal liability for the wayward owners.

Personal Guarantys

Financial institutions and major lenders frequently require the owners of businesses and professional practices to personally guaranty loans granted to those firms. Landlords are also inclined to impose personal guarantys for leases upon owners. Guarantys are imposed with greater frequency for firms which are less than three years old. The guarantor will of course be personally liable for guaranteed debts and obligations.

Offering Personal Collateral

An entity owner who offers his or her personally owned property as collateral for a company debt suffers a personal loss if that collateral must be seized to pay the debt.

Tort Liability

Business owners and the firm’s supervisory personnel can be held personally liable for actions they take on behalf of the legal entity. Professionals will of course be personally liable for their malpractice. In the business context, any action or duty which is performed negligently or recklessly by owners or managers – or by employees “on their watch” – will expose owners and officers to liability for such acts even though the entity is also sued for breach of contract or the like. Along the same lines, legal claims alleging tortious interference with contract or business opportunity, breach of fiduciary duty, and oppression of minority shareholder often target the individuals who run or own the subject company.

Employee Claims

Employees who claim they have been illegally discriminated against in one fashion or another (e.g., race, age, sex), have been harassed, or have been subjected to other illegal employment actions, are usually able to sue the supervisory personnel and owners who acted upon or contributed to those decisions and acts. In many cases, the applicable statutes expressly authorize employees to sue these individuals. See also Cat’s Paw Employer Liability, on this site.

Withholding Taxes

The owner and persons responsible for withholding income taxes payable to a state or the United States government are liable for any failure to properly and fully withhold and pay those taxes. The presence of a legal entity as the taxpayer will not shield the “responsible persons” from this personal liability.

Statutory Liability

Many statutes impose personal liability on business owners and managers for the applicable statutory claims. These statutes are usually topical, as in the case of environmental and whistle blower statutes, which can impose personal liability for entity actions in certain cases. Federal authorities such as OSHA have also sought to expand their reach to the personal assets of business owners by seeking liberal application of legal doctrines such as piercing the corporate veil.

Criminal Liability

In modern day America, criminal laws aren’t just for criminals any more. Congress has passed so many criminal laws that a Wall Street Journal article published in 2011 reported that several experts admitted their inability to count them all, despite their best efforts (one of them stopped at 3,000). There has been no reprieve since then. Many states have of course followed the lead of the Federal government, albeit to a lesser degree. The corporate shield will not protect the owner of a business or professional practice from criminal sanctions, penalties or fines imposed under criminal statutes.

Failure to Designate Entity

An owner seeking the protection of a legal entity must take care to reveal the presence of that entity to the other party. Whenever possible, the owner should designate his or her corporate status when signing or acting on behalf of the legal entity. The failure to do so does not act as a complete “gotcha” for other parties, since they are frequently charged with notice of any filing establishing the legal entity. An owner should not, however, put much reliance on that doctrine since it tends to be quite limited in operation.

Piercing the Corporate Veil

The prospect of facing “piercing of the corporate veil” sounds ominous and can be when a company or professional practice is run as though it is the owner’s personal bank account. The corporate veil is typically “pierced” to reach the owner’s assets when the entity has been abused; that abuse can take many forms. While this relief from the corporate shield is frequently pursued, fortunately for entrepreneurs and professionals this pursuit is not as frequently rewarded.

Undercapitalization

Undercapitalization of the entity is frequently considered a form of piercing the corporate veil. The owner who does not allocate sufficient funds and resources to the entity will frequently find that courts are willing to remedy this wrong by allowing creditors and claimants to reach his or her personal assets.

Unlawful Withdrawals

In Michigan, entity owners will be liable for that company’s unpaid debts and liabilities to the extent they withdrew or received funds or assets from the defunct legal entity. In these circumstances, the creditors and claimants are legally entitled to literally “follow the money.” This office has successfully done just that for several of our clients.

SUMMATION

This list is long but unfortunately for the business owner it is not comprehensive. Nonetheless, you should take heart; thousands of privately-owned businesses thrive and continue to operate daily without running afoul of these potential sources of liability. You just need to trust your entrepreneurial instincts and your professional advisors (including us) to defend your personal castle against the forces who would ram the barricades.

Here at Lambert & Lambert PLC, we don’t leave you with unresolved musings about the problems. We prefer talking about the solutions. Along these lines, you should review our companion article, Securing the Castle: Asset Protection for the Entrepreneur, to examine many of the valuable legal tools we can employ for your benefit to avoid the harmful potential liability explored in this article.

Caution: This article provides general information and is not intended to be legal advice. Your personal circumstances likely vary from those discussed in this article. You should contact Lambert & Lambert PLC if you are seeking specific legal advice regarding the topics discussed above.

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