Protecting business owners from liabilities
- February 23, 2010
A major concern for business owners and professionals is the threat of lawsuit. In today’s litigious environment no business or business owner is immune. If a business is sued, the plaintiff will likely go after the owner’s personal assets. To protect oneself from personal liability, business owners should create a corporation or Limited Liability Company (LLC). (Note, professionals, such as doctors, lawyers, CPAs and architects, cannot protect themselves from personal liability by forming a corporation or LLC — so the discussion below applies to non-professionals.)
Incorporating or creating the LLC is a critical first step to protect the business owner’s personal assets. (For convenience, I will refer to a corporation and LLC as only “corporation,” but the discussion applies equally to LLCs.) However, it is possible that, even though the corporation is created, plaintiffs will assert personal liability against the owners. That is, plaintiffs will seek to “pierce the corporate veil.” To avoid this, it is important to maintain the corporate formalities. These formalities ensure that the corporation is not only created, but also operated and maintained properly.
Corporate formalities include preparing and observing written bylaws that outline how corporate affairs are handled; holding regular annual meetings for shareholders and directors; and maintaining a corporate book that includes up-to-date records of stockholders and capital contributions.
Further, business should be conducted in the corporate name by signing corporate documents as an officer rather than in individual name. Also, separate bank accounts and records should be maintained.
Even if formalities are not followed, there is good news for Virginia business owners: Virginia courts have been reluctant to disregard the corporate form even if some corporate formalities are disregarded. For example, in a 1995 case, a couple purchased a home from a corporation. The selling agent was also a shareholder in the corporation that was selling the house.
The house ended up having numerous defects and, as a result, the new purchasers brought an action against the corporation. The couple also tried to pierce the corporate veil by suing the agent personally because his real estate company and the corporation that did not follow proper formalities. The court refused to impose personal liable on the agent, stating that the business owner does not lose the corporate protection simply because some corporate formalities were not followed. [For those interested, the case was: Ell, et al. v. Moss, et al., 38 Va. Cir. 8 (1995)].
In another case, [Lake Motel, Inc. v. Lowery, 224 Va. 553, 560, 299 S.E.2d 496, 500 (1983)], the court refused to impose personal liability on a shareholder/director for an improper corporate sale of property, stating that, in the instance of small corporations, internal affairs are not always handled with the proper formalities.
Notwithstanding the free pass Virginia courts often provide business owners in these cases, there is the real possibility that, if corporate formalities are not followed, a business owner will be personally liability. So creating the corporation and observing the formalities is the only way to confidently know your personal assets are protected.
John P. Dedon is a principal in the firm with the Trust, Estate & Tax Planning practice group of Odin, Feldman & Pittleman. Dedon blogs about estate planning issues for Virginians and U.S. citizens at dedononestateplanning.typepad.com.