The Value of a Limited Liability Entity By and large

Yous take probably heard that you need a limited liability business entity (corporation, LLC, etc.) to protect you from personal liability. There'southward a well-known company that runs ads on the radio often. The company provides incorporation services. They're non a law firm, they simply file papers to class corporations and express liability companies (that may be their exact words, really!). Their ads sell fear – fearfulness of losing everything if your business concern is sued and you didn't set the business up to operate through an entity that provides liability protection.

General partners (in a general partnership or express partnership, but not the limited partners in a limited partnership) and sole proprietors are subject to personal liability. They don't have an entity liability shield. This means that if at that place is an incident in their business organization that results in a loss or a lawsuit, the owner's personal assets are at take a chance.

Corporations and limited liability companies, on the other hand, offer personal liability protection. The liability protection offered by these types of business organization entities helps ensure that a loss or incident that occurs in your business doesn't upshot in exposure to your personal finances and assets. Every bit is always the instance in law, there are exceptions (we'll talk more than about those below), although generally speaking, these types of entities will shield you from sure types of personal liability risk.

In that location are other types of limited liability entities. For case, I am a licensed attorney in Texas and Delaware (Delaware is the hub of corporate police force in the U.s.a.), and both Texas and Delaware allow founders to create do good corporations (also sometimes called public benefit corporations). Benefit corporations are a special type of for-turn a profit concern favored by social entrepreneurs. Whereas, in a regular for-turn a profit corporation, the officers and directors (on the lath of directors) demand to always put the interests of the corporation first (a mantra that is sometimes translated as requiring the officers and directors to maximize profit to the shareholders), in a benefit corporation the officers and directors tin, really they must, consider the needs of a particular public grouping or cause. To read more well-nigh benefit corporations, visit Corporate Law Gets Aggressive – All Well-nigh B Corporations.

Ii Main Types of Liability

There are ii main types of liability to consider: tort liability and contractual liability.

Contractual liability is incurred when yous agree to do something for another person. It includes everything from service contracts in the ordinary course of business to bank loans. To protect yourself, you need to ever contract in the proper name of, and equally an agent of, your entity to aid ensure protection from contractual liability. You don't want anyone to go to your personal assets. One caveat is that banks will often require y'all to personally guarantee your loans (and pledge concern assets as collateral). Landlords may also require this in a commercial lease (in fact, they well-nigh always will unless y'all pay a much higher security deposit or have a very strong business fiscal argument). However, you should sign your other contracts in the name of the concern equally often as possible. You lot do this by listing the company as the signer and using your company title. Do non sign ", individually" or "in his/her personal capacity" or something else along those lines.

Tort liability is incurred because of your tortious action towards another person. I am sure yous're familiar with negligence. The textbook definition of negligence is a failure to act with the level of intendance that a reasonable person would use under the same circumstances. Damages resulting from negligence are a tort liability. Your entity will protect your personal assets from tort liability, equally long every bit you are non the person who committed the tortious act (or in a couple other situations – encounter below). If your employee or agent commits a tort, that employee or agent (and sometimes the entity) might exist held liable. Withal, you always remain responsible for your own torts.

Potential Liability Fifty-fifty if Y'all Form an LLC or other Limited Liability Entity

Of course, if yous class an LLC or corporation in Delaware or Texas (or anywhere else in the U.Due south. for that matter), you look the entity to shield y'all from personally liability. And, if y'all exercise things properly (forming the LLC, corporation or other type of entity) and maintaining it properly, it volition provide a lot of protection. However, it'due south not bulletproof.

To farther explain potential liability, the following situations illustrate how members (owners) may be held personally liability for an LLC's obligations. The same things could happen to shareholders in a corporation or limited partners in a limited partnership:

  1. Members of an LLC who personally participate in tortious conduct (bad acts) of the visitor may be held personally liable for the consequences of their conduct. Agents or officers may exist similarly liable whether or not they are acting on behalf of another or the LLC.
  1. Members or managers* of a limited liability company may exist personally liable if, in their individual capacities, they impairment someone else's contractual or business organization relationships. For example, if a member makes a downwardly payment nether a contract of the LLC to purchase real estate and uses a personal bank check, and that check bounces, he is personally liable for the bad cheque.

*Managers of a express liability company are non what you commonly call back of equally a managing director. "Manager" is a special blazon of oversight/governance position in an LLC, kind of (not exactly) like directors on a board of directors of a corporation. When you lot course an LLC, you choose to go far member-managed or managing director-managed (when you lot form an LLC in Delaware, y'all don't demand to elect to be manager-managed, you lot can simply do it in your Operating Understanding. In Texas, you need to state that the LLC will be director-managed in the Certificate of Formation you file with the Secretarial assistant of Land to form the LLC. Y'all are non required to have managers in an LLC in either Delaware or Texas)

  1. Even if officers and agents of the company are not participating "hands on" at every pace, they may be held personally liable for misconduct. This liability is non based solely on their membership in the LLC. Rather, it is the fact that they are nowadays and participating in the operations of the company while a violation is beingness committed (either by them or the company) that incurs the liability. The LLC's members are not, still, always liable for bad acts of some other person associated with the company. If an employee commits a tort without approving or knowledge of the fellow member, the member should remain insulated by the LLC.
  1. A fellow member, manager or officeholder of an LLC may be held personally liable for approving, directing, actively participating in, or contributing to the visitor'southward negligent conduct. Or, nether a theory of liability known as negligent hiring (FYI, I don't handle negligent hiring matters – that'southward more in the realm of litigation and I'chiliad a transactional lawyer. However, if y'all take a question about it, I can recommend some other corporation business organisation lawyer in Austin, San Antonio, Houston or Dallas).
  1. Managers of an LLC, directors of a corporation and sometimes fifty-fifty members of an LLC and shareholders (minor betoken – in Delaware General Corporation Law, shareholders are called stockholders, although they are called shareholders in Texas – they're the same thing. But corporate police beingness a tiny bit disruptive) may be held to a high standard of dealing with others in the LLC (other managers, members, shareholders). Sometimes, depending on the context, one of these people may be deemed to owe fiduciary duties to the others. Fiduciary duties are a loftier level of intendance (as a business chaser in Austin, I owe my clients fiduciary duties) – honesty, fairness, confidentiality, prudence, disclosure and good religion (the exact fiduciary duties may vary depending on the position and context).
  1. Officers and shareholders of corporations, members and managers of LLCs, and limited partners in limited partnerships and limited liability partnerships may exist held responsible if the company does non pay certain federal and country revenue enhancement liabilities. Generally speaking, this will require that the individual had some level of command over filing the tax returns and paying the taxes. If they do, be careful – the taxing authorities have very broad reach to collect taxes and they will go right around the entity to collect from responsible individuals.

Vulnerabilities of Liability Protection: Piercing the Corporate Veil

In that location are express circumstances where the liability shield of a registered legal entity may be pierced and the individuals associated with the entity can exist held personally accountable. This "piercing" is referred to as piercing the corporate veil. Knowing when this could occur is an important factor in asset protection since a piercing consequence defeats the central purpose of forming a limited liability entity in the first identify. Piercing the veil of an entity will upshot in liability just like the five "carve-outs" from liability protection we discussed higher up. The difference, though, is the carve-outs are ever a chance, whereas, if you form and maintain a limited entity properly, the veil volition not be pierced.

The veil of liability protection provided by an entity may exist pierced based on the following theories:

  • Alter Ego Theory. If you run your company every bit piffling more than your "alter ego," every bit a mere extension of yourself (this will generally exist the instance where there is a lack of separateness betwixt you individually and the company itself, due to commingling of funds, lack of proper governance, and other factors).
  • Fraud . The owners of the entity use information technology as a sham to perpetrate some blazon of fraud. For example, if you run a business as a corporation and the corporation is sued, yous can't take all its avails and transfer them to a new corporation and then close downwards the erstwhile one, all to avert responsibility to the plaintiff
  • Illegal Purpose . This applies if you lot course a corporation or other entity to perpetrate an illegal purpose.

Steps to Take to Ensure Your Company Provides Liability Protection to You

To maintain the liability insulation that a limited liability entity provides, take these practical steps:

  • Adequately Capitaliz e the Entity Y'all Class. Adequately capitalize your company (at that place is no specific required amount. Your company's specific circumstances, including what types of services or products you sell, will affect what is considered "acceptable").
  • Keep Corporate Formalities . Attach to the corporate formalities set up forth in your company's operating agreement, such as meeting schedules, record keeping requirements, etc.
  • Do Not Commingle Assets . Do non commingle the assets of the entity and the members (i.e. separate everyone's personal coin from the business' money).
  • Properly Pay Distribution Pay distributions to members (called dividends when they are paid to stockholders) and other holders of economic rights according to the terms of your bylaws or shareholders understanding (in a corporation), operating agreement (in a limited liability company) or other governing certificate(southward). Nevertheless, don't always make a distribution if, after making the distribution, the company will be unable to pay its liabilities every bit they come due in the ordinary course of business organization.
  • Regular, Consistent Accounting Practices . Keep a regular, thorough and accurate accounting of the company's finances.
  • Provide Proper Oversight of Officers . Ensure your officers properly perform the tasks delegated to them.

Another Layer of Liability Protection: Business Insurance.

Liability insurance covers risk your business might confront, such as accidents and certain types of lawsuits. A basic grade of liability insurance is commercial general liability insurance. Professionals (like lawyers and engineers) may carry errors & omissions insurance (also sometimes called professional liability insurance). The types of negligence professionals may be sued for would not be covered under a general liability insurance policy. Talk to a knowledgeable insurance banker to find the right insurance coverage for your business.

The dandy thing about insurance coverage is that in that location will be money bachelor to defend and pay a claim. If your business is sued for a significant incident or accident, plaintiff'due south lawyers will try badly to notice someone responsible to pay, preferably a person or entity with "deep pockets." If your business organization has very little avails or greenbacks, a plaintiff's lawyer may work actress hard to bring a lawsuit against you personally if there is any possible argument for doing so. Insurance offers a possible solution – an available puddle of funds.

Conclusion on Forming LLC or Coporations

Ultimately, there is gamble in business equally in life. If formed and managed properly, though, a corporation, limited liability company, benefit corporation or other entity can assistance protect you from some of your business risk and ensure that it's an acceptable amount of adventure relative to the upside in your business organization. Observing these basic considerations will maximize the likelihood that the benefits and purposes of limited liability volition be preserved

Since forming an LLC or corporation or other express liability entity will not protect y'all from every possible risk and liability out at that place, consider business organisation liability insurance. Also, accept operational steps to reduce risk, such as implementing strong company policies (including hiring and management policies) and workplace training.

If you have questions about liability protection, forming an entity in Texas, Delaware or anywhere in the U.Due south. (my website url may say that I am a business chaser in Austin, although with about corporate law matters, physical proximity is non important unless yous want information technology to exist), or other questions about business concern law, delight get in bear on.

Author: Brett Cenkus

Brett Cenkus is a business attorney with 18+ years experience based in Austin, Texas. He has worked with a multifariousness of businesses and has clients throughout Texas too as many technology clients throughout the Usa. Brett is a Harvard Law graduate with a sharply seasoned mind and an entrepreneurial eye. As a founder of 6 companies himself, he is especially passionate nigh helping startups succeed. In 2016 Brett was named the winner in the Individual category for RecognizeGood's Ethics in Business & Community Award. He offers businesses solutions that are in sync with their culture, goals and values. Y'all can learn more than about Brett by visiting the Nearly page on this website.