One of the biggest misconceptions in business law is the belief that forming a Limited Liability Company (LLC) or corporation provides absolute protection from personal liability. While these business structures do offer important protections, they are not impenetrable shields against all legal and financial risks.

Many business owners assume that once they set up an LLC or corporation, their personal assets are completely safe from lawsuits, debts, or financial obligations. However, there are several exceptions and loopholes that could still expose business owners to personal liability.

Let’s debunk this myth and make sure you can avoid all the liability pitfalls for your business.

Failure to Follow Corporate Formalities

Every year there are filings for your corporation or LLC.  Failure to file these can have devastating effects on  your liability protection.  It’s a trade off.  In return for filing your annual report, taxes, and keeping your internal paperwork up to date, you receive a big benefit, separation of liability.  Protection of your personal assets.  If you are sued, a successful plaintiff should only be able to access any assets owned by that entity.

And don’t forget, there is internal paperwork that must be maintained.  Not just those annual filings with the state and the feds.  When’s the last time you created a resolution or took minutes for meetings?  You may think, it’s just me in the business, there’s no one to meet with.  This may be true, but your decisions still need to be documented.  Remember, the law sees you as filling different roles in your business, and the decision still need a formal documentation.

Commingling Funds

This is one of the easiest and most common ways that business owners get into a murky area with their liability protection.  When you create a corporation, LLC or Non-Profit, the financials must all be separated from your personal or other business finances.  This means you must have a separate business checking/savings account, separate credit card, etc.  Everything needs to be in the name of the business.  And most importantly do NOT use business funds to pay personal expenses and vice versa. If you pay yourself to reimburse for expenses, take a salary, take a distribution and the like, then it must all be accounted for in your tax software the right way.

UnderCapitalization

Capitalization is the money available to a business at any given time.  You capitalize a business when it’s started and throughout the life of the business.  You must maintain a minimum amount of funds or capital so that the business can cover its debts and liabilities.  If it’s not properly capitalized, then your business could be viewed as a shell company, not a legitimate legal entity, and you could lose that liability protection.

The Personal Guarantee

What is a Personal Guarantee?  A personal guarantee is a legal promise made by an individual (usually the business owner) to personally repay a business debt or obligation if the company cannot. It’s often an attachment, or a part of, a contract that you may sign such as a loan or a lease. This means that even if the business fails, the owner remains personally responsible for repayment.

Why Would I Sign One? Many lenders, landlords, and suppliers require small business owners—even those with an LLC or corporation—to personally guarantee loans, leases, or contracts. Particularly if the LLC does not have a long financial history.  It’s riskier for the other party to make an agreement directly with the LLC that may not have the financial history and backing to pay what is due.

What is the Effect of Signing One?  If you sign a personal guarantee on any legal agreement it means you are promising that your personal assets (such as your home or savings) can be used to repay the debt and that you personally will still be responsible for payments if the business can’t pay.

Fraudulent or Misleading Behavior. Last but not least, creating a Corporation or LLC will not protect you from illegal activity.  So if you engage in fraud, deception or dishonest business practices then you will still be personally liable for these actions.

What You Can Do to Protect Your Personal Assets

1) Follow All Legal Formalities
2) Keep Business and Personal Finances Separate
3) Properly Capitalize Your Business
4) Avoid Signing Personal Guarantees or Limit How Long They Will Be Valid
5) Avoid Fraudulent or Deceptive Practices

If you’re a business owner, it’s crucial to set up your company correctly, maintain it properly, and seek legal guidance to maximize protection.

Need help ensuring your business is legally protected? Schedule a free consultation with us today!

AMC Legal Can Help

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  We can advise you about all of these pitfalls.

• We offer a yearly review of your corporate book and filings to make sure you’re in compliance.

• We can file your annual report and keep your corporation/LLC book up to date.