Incorporation: Shielding Your Assets From Lawsuits And Liabilities

Incorporating your business can provide a layer of protection from personal liability, but it is not a foolproof method. While incorporation can shield your personal assets from common lawsuits against your business, such as negligence claims or employee lawsuits, it does not offer complete protection in all scenarios. For instance, if you personally cause harm or commit a crime, both you and the corporation can be held liable. Additionally, small business owners with limited liability companies (LLCs) might find that incorporation does not provide a significant liability shield. It is important to understand that incorporation does not absolve you from all potential lawsuits, and seeking legal advice is always recommended to ensure adequate protection.

Incorporation does not protect you from every lawsuit

Incorporating your business can provide a layer of protection from personal liability. However, it is essential to understand that incorporation does not shield you from every lawsuit or scenario. Here are some key points to consider:

Piercing the Corporate Veil

Incorporation does not offer absolute protection in all circumstances. This concept is known as "piercing the corporate veil," implying that there are times when the corporate structure can be disregarded, and personal liability may arise. This typically occurs when specific requirements, such as maintaining separate corporate and personal finances or adhering to corporate formalities, are not met.

Personal Actions and Harm Caused

Incorporation does not protect you from the consequences of your personal actions. If you, as the owner or employee, personally cause harm or engage in illegal activities, you can be held personally liable. For example, if you negligently cause an accident with a company vehicle, both you and the corporation can be sued, and the corporate shield will not apply.

Small Business Owners and Loan Guarantees

Small business owners often incorporate with the belief that it will protect their personal assets. However, this may not always be the case, especially if they are the sole or primary employee. Additionally, obtaining loans for small corporations often requires personal guarantees, meaning the owner will be personally responsible for repaying the loan if the corporation defaults.

Board Member Duties and Conflicts of Interest

Board members of incorporated entities are expected to act in the best interest of the business, following the prudent person rule. Deviating from this duty, such as engaging in conflicts of interest or making decisions for personal financial gain, may result in the loss of the liability protection offered by incorporation.

Insurance and Creditor Considerations

Incorporation may not provide complete protection from business creditors. It is crucial to have adequate insurance coverage to protect against potential lawsuits and liability claims. Failure to obtain appropriate insurance can expose both the corporation and its owners to personal liability.

In summary, while incorporation can offer a level of protection, it is not a guarantee against all lawsuits. It is important to understand the limitations and exceptions to this protection and take additional steps, such as obtaining insurance and adhering to legal requirements, to safeguard your personal assets effectively.

Protection from personal liability

Incorporating your business provides a layer of protection from personal liability. The general rule is that corporations are treated as people under the law, and people performing services on behalf of a corporation cannot be held personally liable if those services go wrong. However, it is important to note that this protection is not absolute and there are times when it may not apply.

One key requirement to maintain corporate protection is the Rule of the Prudent Person. This states that board members are assumed to act reasonably and in the best interest of the business. As long as they adhere to this rule, they are protected from personal liability. However, if their actions are deemed to be contrary to their duty, this protection may be lost.

Another important aspect is the Duty of Loyalty. Board members should avoid conflicts of interest and refrain from making decisions that benefit themselves or their families instead of the business. If they engage in such practices, they may lose the protection from personal liability.

To further protect yourself, it is advisable to create bylaws that prohibit personal gain at the expense of the business and discourage doing business with companies that benefit board members. Additionally, ensure that important actions and decisions are documented, and company funds are kept separate from personal funds. Obtaining adequate liability insurance can also enhance your protection.

While incorporation offers a level of protection, it is not a guarantee against personal liability. There are exceptions and complexities, and it is advisable to seek legal guidance to ensure you are taking the necessary steps to maintain corporate protection and safeguard your personal assets.

Protection from business debts

Incorporating your business can provide a layer of protection from personal liability. However, this protection is not absolute, and there are exceptions to the general rule of separate corporate personhood. As a board member, you are protected from personal liability as long as you act "as a reasonably prudent person under the same or similar conditions". Conflicts of interest should be avoided, as protection may not be available if actions or decisions are made to benefit yourself or your family instead of the business.

The structure of your business will determine who is responsible for paying business debts. In a sole proprietorship, you and your business are equally liable for debts incurred by the company. An LLC or corporation, on the other hand, will generally shield members and stockholders from personal liability. However, this protection can be pierced if creditors can establish a unity of interest and ownership, suggesting that there is no difference between the operation of the business and the personal affairs of individuals.

To increase the odds that an exception will not apply, there are several things you can do. These include obtaining adequate liability insurance, clearly documenting when someone is performing services on behalf of the corporation, and properly supervising people who work for the corporation. It is also important to follow the formalities and legal requirements for the operation of the business, such as issuing membership certificates, holding annual meetings, maintaining meeting minutes, and using a separate bank account for all business activities.

In summary, while incorporation can provide some protection from business debts, it is not a guarantee. By taking certain steps, you can increase the odds that you will be protected from personal liability in the event of a lawsuit or business debt.

Protection from customer claims

Incorporating your business can provide a layer of protection from personal liability. However, it is important to note that this protection is not absolute and there are exceptions. For example, if you are both the owner and one of the principal employees of your small company, incorporating may not offer much protection from liability. Similarly, if you own a very small corporation, you may have to use your personal funds to fight a lawsuit, even if you are not technically liable for the corporation's debts.

To enhance your protection from customer claims, consider the following:

• Obtain adequate liability insurance, such as business property, professional errors and omissions, and product liability insurance. This can help protect your personal assets in the event of a lawsuit.
• Create bylaws that prohibit personal gain at the expense of the business or doing business with companies that benefit board members. Encourage board members to carefully consider and document the reasoning behind key decisions.
• Ensure that board members act in the best interest of the business and avoid conflicts of interest. The "prudent person rule" states that board members are protected from personal liability when acting as a reasonably prudent person under similar conditions.
• Clearly document when individuals are performing services on behalf of the corporation. This can help establish that the corporation, rather than individuals, is responsible for any issues that may arise.
• Properly supervise people who work for the corporation. This includes employees and contractors, as their actions can impact the liability of the corporation and its members.

By following these steps, you can increase your protection from customer claims and reduce the risk of personal liability. However, it is always advisable to seek legal advice specific to your situation to ensure you are taking the appropriate steps to protect yourself and your business.

Piercing the corporate veil

Incorporating your business does provide a layer of protection from personal liability. However, there are times when that protection does not insulate you completely, and a court may decide to "pierce the corporate veil".

This typically occurs in smaller privately held business entities (close corporations) with a small number of shareholders, limited assets, and where recognition of the separateness of the corporation from its shareholders would promote fraud or an inequitable result. For example, if a corporation is deemed to be the "alter ego" of its shareholder(s), used to avoid legal limitations, or is a sham to perpetrate a fraud.

There is no record of a successful piercing of the corporate veil for a publicly traded corporation due to the large number of shareholders and extensive mandatory filings. In the UK, piercing the corporate veil is very rare and usually only occurs when a company is set up for fraudulent purposes or to avoid an existing obligation.

To avoid piercing the corporate veil, it is important to maintain the separation of business and personal assets, create and regularly update bylaws, document major business decisions and meetings, and obtain adequate liability insurance.

Frequently asked questions