Choosing the Right Form of your Business
A Legal Moment

Avoiding Personal Liability as a Business Owner

Choosing the proper form for your business can make an important difference in protecting your personal assets.

   Although there are many reasons a prospective owner should consider in choosing the legal form of his or her business, among the most important is limiting the owner’s personal liability for actions of the business.

      In two common situations business owners are, by default, personally liable:  when an individual operates a business as a sole proprietor, or when two or more individuals operate a business as a general partnership.  In either case, the owners have unlimited personal liability for the obligations and wrongful acts of the business.

    This exposure can be quite hazardous to the owners’ personal fortunes. For example, if an employee of a sole proprietor injures another person while performing his or her employment duties, the owner is liable for that injury.  As another example, if one general partner incurs a large debt on behalf of the partnership, all partners are liable for repayment.   For reasons such as these, most business owners form a business entity to limit their individual liability.

    The most popular limited liability business entities are corporations and limited liability companies.  For both of these entities, absent extraordinary circumstances, the owners are not personally liable for the acts or debts of the business.

    In addition to protecting the owners, both corporations and limited liability companies also provide additional protection for those who manage the business.  

    In the case of corporations, this means the directors and the officers regardless of whether they are also owning shareholders.  When a director or officer is sued because of his or her status as a director or officer, the corporation must indemnify him or her for the acts he or she took on behalf of the company so long as she was acting in good faith and in the best interest of the business. In other words, the corporation must pay for expenses and losses incurred in defending the lawsuit.

    In the case of limited liability companies, those responsible for management are called managers, who are frequently, but not necessarily, also the owners.  When a member or manager is sued because of his status as a member or manager, the limited liability company must indemnify him or her in a manner substantially the same as corporate indemnification.

    As with all things legal, there are of course some exceptions to the limited liability shield of business entities:

•    An owner’s personal investment of capital into the business is at-risk with no guarantee of its return.  If that investment is necessary to settle a lawsuit claim or pay a debt, the owner cannot get it back.  However, the owner is not required to invest more to cover a claim.  With limits, owners may reduce their at-risk capital by loaning money to their own business instead of investing it directly.

•    If business owners do not run the business properly, a court may order a “piercing of the veil” such that the owners are personally liable for claims against the business.  Factors that may lead to “piercing the veil” are failure to follow the record-keeping and report-filing requirements of the business and, especially, commingling business and personal assets and debts.

•    If the business provides a professional service, such as law, medicine, or accounting, there is no liability shield for the professional malpractice of the licensed business owner.

•    If a creditor requires an owner to sign a personal guaranty for a business debt, as lenders almost always do, the owner is personally liable for repayment of that debt.
    These exceptions notwithstanding, with some careful planning and management, owners can rest a bit easier on the risks they face as owners by significantly reducing their personal liability exposure simply by operating as a corporation or limited liability company. Owners should continue to use other risk reduction techniques such as maintaining all desirable insurance coverages.

    Finally, business owners need to consider many other factors when choosing a business entity besides the limitation of liability discussed in this article.  Among those factors are tax treatment of the entity, management structure, restrictions on transfer of ownership interests, capital structure, formation costs, requirements for record-keeping and administrative formalities, and many others.  For these reasons, owners should consult their legal, accounting, and financial advisors when forming or re-forming their business.


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Greg Gregory is an attorney and shareholder at Marshall, Roth & Gregory, PC. Greg's practice encompasses all forms of business and real estate transactions.
   Feel free to contact Greg ( to receive more information on this topic or to suggest topics for future editions of 'A Legal Moment'.

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   You may not rely on this content as legal advice for any specific situation, but should instead contact an attorney for specific advice
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