When Is There Personal Liability for LLC and Corporate Debts?
Many people opt to do business as a corporation to limit their personal liability for their businesses’ debts. In essence, the business owners and/or corporate officers form a separate entity, and do business together as the entity. The entity itself will be liable for its own debts.
However, this is not a guaranteed method for the business owners to forgo all personal liability. Depending on whether corporate formalities are followed, the business owners may still be personally liable for their businesses’ debts.
Below are instances where personal liability is found.
Cosigning a loan is a voluntary act, in which the cosigner guarantees the debt of another. In other words, the cosigner is allowing the creditor to go after him for repayment if the borrower cannot pay. As such, this act is completely separate from the duties of a business owner of a LLC or corporation. By cosigning, the cosigner will be personally liable for the corporate debts even if he would not be if he were merely an owner.
A creditor may force a business owner to pledge some of his property as collateral if his new business does not have many assets. Thus, if the business entity is unable to repay its loans, then the creditor can take the collateral. Collateral normally comes in the form of property such as the business owner’s house.
The good thing about the collateral is that the business owner and officer will only be personally liable for whatever the collateral is only. So, if the debt is greater than the collateral pledged, then the creditor cannot go after his other assets.
Piercing the Corporate Veil
The corporate formation of your business entity can only protect you if it was formed properly, all officers followed the corporate rules, and the business entity is indeed a separate entity from the owners. If not, then the owners will not be protected by the business entity.
In essence, the corporate veil that protects the owners and officers from personal liability will be pierced if:
- Corporate formalities, such as mandatory meeting minutes, are not followed;
- Owner exerts too much control over the business entity;
- Owners are commingling their personal funds with the corporate funds; or
- Corporation was not funded sufficiently to protect against foreseeable debts.
If the owners or officers committed fraud in anyway, then they may be personally liable for the business entity’s debts. For example, if the owners and officers lied on a loan application or if they formed the business entity for the purpose of committing fraud.
Consulting an Attorney
If you are interested in forming a LLC or corporation, please contact a business lawyer. He will draft you formation documents properly and advise you on your acts such that you will not be personally liable for any future debts of the business.
Authored by Mabel Yee, LegalMatch Legal Writer.