The Role of a Corporation or a Limited Liability Company in Protection of Personal Assets
Business activity involves risk. It is the owner’s willingness to take a gamble, to accept risk that gives him the opportunity to make a profit. No one starts a business expecting to fail. However, not all businesses are profitable. Even those that are profitable sometimes stumble: a claim by a disgruntled customer; the failure of a product that was purchased and resold; an employee whose negligent actions hurt others. The possibilities are numerous and can impact even the careful, responsible business owner. For that owner, or for the entrepreneur starting a new business, sooner or later the question arises: How can I protect my personal or family assets from claims against the business? The knee jerk response is: form a corporation—form a limited liability company (LLC). Everyone knows that will protect me. Right? The answer, as is typical in legal matters is: it depends.
The starting point is: what do you mean when you say you are forming a corporation or LLC? For many people the answer is simple—file articles of organization with the Secretary of State and get a Certificate of Good Standing. This is easy. This is inexpensive. It can be done by a layperson without the aid of a lawyer. However, it is an illustration of the axiom that the law does not normally give you something for nothing (or even something for almost nothing). Filing the articles is a necessary first step, but if your goal is to protect your personal assets, it is not sufficient. If a claim is filed against the business, the claimant’s attorney will request the business records to determine if the corporation/LLC is a real, independent entity or if it is simply the owner using it as a shell to shield personal assets. The argument by the claimant’s attorney will be that the entity is not real, but is just the owner acting under a different name. The fancy legal term is that the entity is the alter ego of the owner.
How does the owner insure that this alter ego argument will not put personal assets at risk? He goes further than simple registration. He holds an initial meeting of his stockholders and elects director who, in turn, elect officers. He adopts formal minutes of these meetings and holds them annually. He issues share certificates. He maintains separate bank accounts for the entity and is careful not to use them to pay his personal expenses or otherwise co-mingle personal and corporate funds. Most importantly, he puts some assets into the entity. Where practical, he also buys insurance for the company. These actions will make the corporation a credible, viable entity which is separate and distinct from the owner and his family.
Each case is different. Each depends on its own set of facts. There is no “set formula” for achieving personal asset protection. That is why I encourage clients who are facing these questions to get goodlegal advice and to follow it. The cost saving you achieved by using standardized forms or by a “do it yourself” approach rarely looks significant when the business is served with a claim and a court proceeding looms.