Why am I still talking about lawsuits? Last month we reviewed the benefits of limited liability protection available in the form of a corporation or LLC.  But there is a little more to the story…..

Remember, business liability arises out of the operation of your business or ownership of property.  An LLC or corporation (a “business entity”) can help shield your personal assets from business liability.  But what if you have signed a personal guarantee?  If you need a business bank loan, you can count on the bank asking you (and maybe your spouse or business partners) to sign a personal guarantee in most cases.  The personal guarantee ensures that if the business is unable to repay the loan, then the bank can recover from your other financial  assets; this is basically an end run around the limited liability protection of the business entity.  Personal guarantees are also common in commercial office leases, equipment purchases or other commercial contract relationships with suppliers.  It is crucial for you to understand what you are signing and what exposure you have in these various business relationships.  You may have signed personal guarantees and not even realized it.  Be very careful when you sign any documents related to these types of transactions and make sure you are aware if you are undertaking personal liability.  Also be very careful how you sign on behalf of your business entity — you should always indicate your title (e.g., President, Manager, etc); that way it is clear you are signing only in your capacity as an officer for the company and not as an individual.

I also mentioned last time the importance of following corporate formalities in the operation of your business entity.  What I mean is that you can’t simply create an entity in name only.  You have to actually operate your business through the entity.  Again, use your entity name in all of your contract relationships.  Maintain bank accounts for the entity and handle all inflows and outflows of revenue through these accounts.  File your business annual reports with the Secretary of State each year.  Be consistent in your tax reporting; usually you need to prepare a separate tax return for your business entity.  Why are corporate formalities important?  You are trying to avoid an argument by a creditor that your business entity is simply a sham, and that the creditor should be allowed to collect against you individually.  This is known as “piercing the corporate veil.”  That’s all of the legal jargon I want to include on this, I think you get the point…pun intended.

Finally, consider options to protect against liability with insurance.  Professionals such as lawyers, CPAs, and doctors, carry professional liability insurance largely because they have personal liability exposure  for mistakes they make regardless of whether they operate through a business entity.  For other businesses which don’t involve typical professional liability, there is Errors and Omissions (“E & O”) insurance.  Most E & O policies are designed to cover liability arising out of your or your employees’ negligence — somebody made a big mistake and now the client is mad and has lost money.  If you are sued in this case, your insurance company helps defend you and ultimately pays for any claims that are successfully made against you (as long as they are covered by the policy).  The terms of the policy are very important so read it carefully.  In my experience,  many, if not most, businesses don’t carry E & O insurance, so don’t assume that is an absolutely necessity, but it may help you sleep better at night if you are worried about your exposure to this type of liability.