You’ve Formed a Liability-Limiting Business Entity – Are You Protected?

Another in a series of posts about legal issues that arise for early-stage businesses.

You’ve formed a liability-limiting business entity and now expect to reap the benefits of knowing that only those funds, resources and properties committed to the business are accessible by potential creditors. Are you protected? As always in the legal realm, the answer is “it depends.”

Simply forming a liability-limiting business entity is not sufficient to protect you and your co-owners from personal liability due to the doctrine of “piercing the corporate veil.” In the context of early-stage and startup companies, piercing the corporate veil usually turns on the question of “who did a creditor think it was doing business with?”

Let’s say your small business (the “Company”) entered into a supply contract for widgets and, unfortunately, your business received delivery of the widgets, but cannot pay the supplier. In fact, the balance on the invoice exceeds the assets of the Company. If you were following the formalities outlined below, the supplier’s recourse will likely be limited to the assets of the Company, despite the fact that those assets do not cover the full cost of the widgets delivered.

However, if you were not following the below formalities, the supplier could attempt to “pierce the corporate veil” and argue it thought it was doing business with you, the individual, rather than the business entity.

Below are some corporate formalities/actions that can prevent such confusion and stymie a “piercing” action from a potential creditor:

1)      Communicate with third parties in your capacity as an officer/agent/employee of the Company

Sign your emails as “Bob Smith, President of XYZ Company”.

Sign contracts in the following manner:

XYZ Company

By: (signature)

Name: Bob Smith

Its: President/CEO/etc.

2)      Do not co-mingle funds

Your business and your personal finances should be completely separate (except, of course, for when you pay yourself). Payments from customers should be made TO a Company bank account. Payments of bills and other liabilities of the Company should be made FROM a Company bank account. Never pay Company liabilities from your personal account; transfer funds to the Company bank account and pay from there. Otherwise, a creditor could make an argument it thought it was doing business with you as an individual, rather than the Company.

3)      Make the required annual/other filings

Each state has different requirements, but each requires at least an annual filing of its domestic business entities (which includes a small annual fee). Make these filings. If you fail to make these filings a state will “administratively dissolve” your entity; conversely, if you are in administrative dissolution, oftentimes you can restore your standing quickly by paying late fees.

If the Company is a corporation, consult an attorney as to what annual meetings and their minutes need to contain. If the Company is an LLC there are less formalities to follow, but consult an attorney to be sure you’re following them.

4)      Register assumed names with your state/county registrars, as necessary

If the Company has any d/b/a’s (doing business as) names, be sure to register them at both the state and county level. This way, if the Company’s name and the d/b/a name could cause confusion (for example, Bob Smith Industries, LLC d/b/a BSI Manufacturing) you will have some protection.

You may have heard that “corporations/companies are people”. In the legal context – they indeed are. They need to be treated as a separate entity/being from you as an individual. If there is confusion as to where the Company begins and your personal support for the Company ends, you may be undermining the primary reason you likely formed a liability-limiting business entity.

The above formalities become more complicated in the context of parent and subsidiary companies and other more complex scenarios. This information is intended for informational purposes only.  If you like to discuss this article with an AEGIS Law attorney, please contact Alex Prasad (aprasad@aegislaw.com).