What is the deal with limited liability protection? My apologies to Jerry Seinfeld, but I get that question from a lot of my business clients, particularly people starting up a new business.  There are some common misconceptions out there about what a corporation or limited liability company (LLC) can and can’t do to provide protection for you and your assets.

Let’s get one thing straight right away – limited liability protection is different from creditor protection.  If you transfer personal financial assets into your own LLC in order to “protect” the assets from your personal creditors, you are wasting your time.  If a creditor can get a judgment against you personally then that creditor can recover your ownership in the LLC and, effectively, you just lost those assets; not very protected.  I hope none of you has this type of problem, but if you do you need to be learning about creditor protection options which is a topic for another day.

For limited liability protection we are concerned about exposure to lawsuits or claims arising out of your business activity and property ownership, which I lump together under the term “business liability.”  For example, if your business has a fleet of automobiles, then one concern is exposure to liability from your employee’s automobile accident.  Or you may be worried about a tenant at your rental property falling through a hole in the floor because you didn’t get around to having the property checked for termites.  This actually happened to me as a tenant, seriously.  I decided not to sue my parents, which proved to be a good decision.  You may also be concerned about one of your customers suing you because something you did for them went wrong and cost them lots of money.  All of these issues involve business liability.  The point of limited liability protection is to limit that business liability to the assets associated with your business or property and to avoid exposing your personal financial assets (all of your wealth outside of the business) to those claims.

If your business is operated in the form of a corporation or LLC and if you follow the corporate formalities (e.g. keep your personal assets and bills completely separate from the business) then anyone making a claim against your business is limited in what they can recover.  They are free to sue your business entity and, if successful, recover from its assets, but that’s where the limitation kicks in.  They can’t go beyond that and collect from you individually.

Now here’s a very important point that clients never like to hear.  You may still be sued individually even if you operate through your business entity; lawyers like to take a “shotgun” approach.  Limited liability doesn’t protect you from being pulled into a lawsuit; however it is designed to help protect against ultimate recovery against your individual assets.  Also having a business entity may tend to discourage some lawsuits if they claimant knows that the business has very little in assets and if they doubt that they can succeed in suing you individually.  This is why your landlord for your office space will invariably require a personal guarantee from you; they don’t expect to be able to recover from your business.  Obviously if you sign a personal guarantee then at least for that obligation, your business entity is not providing liability protection.

OK I know some of you internet savvy people are saying, “What about malpractice insurance, errors and omissions insurance, or what about piercing the corporate veil or what are corporate formalities?”  All great questions and, as with any good TV season finale, you’ll have to wait til the next season.  Until then, get those floors checked for termites.