Safeguarding Your Business as You Grow

Starting a business involves a certain level of risk, and entrepreneurs must be prepared to face various uncertainties. However, there are steps that can be taken to reduce risk and protect both the business and its owners. One of the key ways to mitigate personal risk is by choosing a legal structure with limited liability. This shields individual assets from the business’s financial distress, providing peace of mind to entrepreneurs. Despite the protective nature of limited liability, it is important to understand its limitations and how to maintain its benefits. In this guide, we will explore the meaning and purpose of limited liability, its historical origins, the factors that could pierce the liability veil, and the steps to maintain limited liability effectively.

The Meaning and Purpose of Limited Liability

Limited liability ensures that business owners and investors are only liable for the amount they invest in the company. Their personal assets remain protected even if the business faces lawsuits or debts. This separation of business and personal liabilities is crucial, as it encourages entrepreneurship by alleviating the fear of losing personal assets in case of business insolvency.

To illustrate the importance of limited liability, imagine if every business owner’s personal assets were at risk if their business became insolvent. Undertaking a new venture would involve too much risk for many individuals, and most businesses would never get off the ground.

Three common types of modern business structures provide limited liability:

• limited liability company (LLC)
• limited liability partnership (LLP)
• corporation

It is taken for granted today that owners of these types of businesses are not responsible for the debts and actions of the business entity. But the LLC has only been around since 1977. And corporate limited liability as we know it only dates back to around 1800. Indeed, modern capitalism is unimaginable without limited liability.

Limited Liability Origins

An early predecessor of the limited liability structure was the joint-stock company, which has its roots in European exploration of the Americas.

Trips to the New World were expensive and dangerous. Entrepreneurs of the day came up with a new business plan. They sold stock in companies that were engaged in voyages to the New World to wealthy individuals, who provided capital in exchange for a portion of the profits but were not responsible for the companies’ actions.

The settling of the American colonies is closely tied to English joint-stock companies of the 1600s. Today, joint-stock companies no longer exist. But the legacy of these early limited liability companies lives on in corporations, LLCs, and LLPs.^[1]

The Limits of Limited Liability

Bifurcation of business and personal assets—the cornerstone of limited liability legal structures—is not absolute. Although courts are generally hesitant to impose personal liability on a company’s owners, they may do so in some situations, such as the following:

1. Improper Formation: If the business entity was not properly formed, such as failing to file the appropriate paperwork with the state, personal liability may be imposed.
2. Torts: Owners or employees committing negligent or reckless actions that cause injury to others may face personal liability.
3. Personal Guarantees: If an owner personally guarantees a business loan, they may become personally liable if the company defaults.
4. Statutory Liability: Some state or federal laws impose personal liability on owners, such as environmental and tax liability.
5. Veil Piercing: Courts may “pierce the veil” of limited liability if owners fail to maintain a clear separation between personal and business affairs, commingle funds, or engage in fraudulent activities.

The term “piercing the veil”^[2] applies not only to corporations but also to LLCs and LLPs. In a general partnership, only the limited partner has limited liability.

How to Maintain Limited Liability

Keeping the limited liability of a corporation, LLC, or LLP intact requires knowing and preventing the circumstances that can eliminate the liability shield. Specifically, owners should understand the following and take the following steps to maintain limited liability:

• File the appropriate paperwork with the state at the time of business formation.
• Torts committed in the business can expose them to personal liability. This can include actions carried out by employees.
• Owners can be held responsible for business debts they personally guarantee.
• Some laws, such as the federal Superfund law,^[3] impose owner liability (owners should also be aware of available defenses, such as acts of God or war in the case of Superfund liability).
• Respect business formalities that make veil piercing less likely. Always hold board and shareholder meetings, pay dividends, and maintain detailed books and records, and avoid commingling personal and company funds to maintain the separateness of the limited liability entity.

Get Help from Our Attorneys

The limited liability of corporations, LLCs, and LLPs is only disregarded in extreme cases. In addition, good business practices will help you avoid situations such as debts and lawsuits that can lead to challenges to the limited liability provided by your business entity.

Of course, business risks cannot be eliminated altogether. If you need help developing liability safeguards or defending your limited liability in a legal action, please contact our office to schedule a consultation.

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[1] Will Kenton, Joint-Stock Company: What It Is, History, and Examples, Investopedia (Jan. 15, 2023), https://www.investopedia.com/terms/j/jointstockcompany.asp.

[2] Piercing the Corporate Veil, Legal Info. Inst., https://www.law.cornell.edu/wex/piercing_the_corporate_veil (last visited May 4, 2023).

[3] U.S. Env’t Prot. Agency, Superfund Liability, EPA.gov (Jul. 25, 2022), https://www.epa.gov/enforcement/superfund-liability.