The general rule is that business entities, such as LLCs, protect their owners from personal liabilities for the business’s debts. This protection is often referred to, in the context of business entities, as the corporate veil.
However, just forming your business as an LLC is not alone sufficient to ensure the Limited Liability Protection for your Business. When a lawsuit is filed asserting that an owner should be personally liable for the business’s debts. This is known as piercing the corporate veil. Creditors may be successful in these efforts in situations where:
The company is severely under capitalized (filing your Business taxes at a loss consistently or other proof that you didn’t have sufficient funds to start a business in the first place.)
The company and its owners did not maintain their separate identities in their business affairs.
The actions of the company were fraudulent or wrongful.
To preserve the corporate veil, there are a handful of guidelines that business owners should consider:
1. Have Adequate Start-Up Capital If the business did not ever have sufficient capital to cover its liabilities, creditors will argue that it was not sufficiently separate or independent from its owners to give rise to a corporate veil. When starting a company, it is important to make a reasonable initial investment in the business in order to avoid this claim.
2. Do not commingle financial affairs The company should have its own bank account and credit card and engage in its own transactions separate from the owners. The individual owners should not utilize the company’s money for their own individual purposes (for example, paying home cable bills) without adequately documenting the transaction as a loan or a draw. If the company needs additional funds and the owner wishes to contribute, this should be documented as a capital contribution, with appropriate documentation created at the time of the transaction.
3. Sign Correctly The business dealings of the company should be carried out in the name of the company, with the company as the named party to any contracts and the individual signer clarifying below the signature line that they are signing for the company—for example: John Smith, as Authorized Member of ABC LLC, for and on behalf of ABC LLC. This reflects the name of the signer, the authority / title of the signer, and the company for which the signature is made.
( a common mistake of DIY business set up is owners giving themselves the wrong title for the LLC)
4. Document Company Business Meetings of the company, if required under the LLC’s operating agreement, should be documented in formal minutes maintained in a professional way with the records of the company. Decisions of the company should be reflected in resolutions signed by the members.
( Even if you are a solo member, sometimes it is a good practice to go through the formalities of keeping minutes and resolutions. Especially where business loans are concerned.)
5. Maintain Your LLC In some states, failure to file an annual report with the state of formation can result in automatic dissolution of your LLC. If your LLC is dissolved by the state, the owners of the business no longer have limited liability protection. You can also make it easy for your name or service mark to be taken, or could compromise any pending patent applications.
Also, If the entity documents were NEVER created before dissolution, any property or assets owned by the LLC could be lost to creditors. By law a title company must review the entity documents before the sell, distributions, or acquirement of property.
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