As a business owner, your focus is likely on how to make sure things go right. However, sometimes the unexpected happens, so it can be helpful to have certain protections in place to make sure that your organization not only survives but thrives.
That said, you may have come across the term “limiting liability” and wondered how this relates to your business. Generally speaking, liability refers to the person or entity that is responsible for a debt.
Now, debt can be incurred in a variety of ways, such as money taken on credit or amounts due under contracts. Without limits in place, you, as the business owner, could be personally responsible for the money owed by your business.
This is important because not all forms of debt are incurred directly by owners or are foreseeable. An example would be if your business is sued, and the court awards a money judgment against your business. If your liability is not limited, those that won the lawsuit may be able to go after your car or your bank account to satisfy any debt that the business can’t pay.
Luckily, there are ways to minimize this risk and help you feel more comfortable about doing business in California.
Business Insurance
Now, one way to reduce the likelihood of having to pay out-of-pocket is with insurance. As you may already know, there are many different types of policies out there, each with separate protections. For that reason, it’s important to understand the purpose behind each type and consider what areas you are interested in limiting your liability.
With that in mind, the most common forms of insurance are:
- General liability insurance: covers you if someone gets hurt at your premises and sues
- Professional liability insurance: kicks in if someone has an issue with the expert advice you offered
- Workers’ compensation insurance: applies in cases where an employee gets hurt
- Commercial property insurance: reimburses you if your business property (like computers or equipment) is damaged due to things like fire or theft
However, it’s important to note these policies will only protect you up to the individual policy limits. This means you can still be personally responsible for anything not covered by insurance if certain additional steps aren’t taken.
Business Formation
Keep in mind that the minute you start operating a business by yourself, the law classifies you as a sole proprietor. The effect of this classification is that there is no legal difference between you and the company. This means that all debts taken on by the business are your debts.
To separate yourself from the business you must do a few things. First, you must choose a business structure. Under California law, you have a few different types of entities to choose from. These include LLCs, nonprofit corporations, s-corporations, and limited partnerships.
As you might imagine, each of these different business types has benefits and drawbacks. Further, each has its own formation requirements, filing fees, and tax structures. For that reason, it’s important to talk to an attorney to see what would work best for you and your unique situation.
However, when properly formed, only the business is responsible for company debts. This means that you can have peace of mind that your personal property will be protected.
Be Careful to Not to Pierce the Corporate Veil
Now, bear in mind that there are certain instances where liability can be imposed on a business owner even when the company is formed as a distinct entity. This is referred to in the law as “piercing the corporate veil” and it means that the legal protections offered by the company disappear. In other words, the veil is pierced, you are treated as if you are a sole proprietorship.
Ths most common way we see this happening is when one or more of the following occurs:
- Commingling of funds – the owner does not have a separate bank account for the business and instead uses his or her personal bank account.
- Undercapitalization – the owner fails to put enough money into the business for it to run
- Ignoring corporate formalities – like a corporation not having board meetings and keeping minutes
- Evidence of fraud or wrongdoing when forming the business – like creating a business just so you could move all of your assets into it to avoid paying child support
- Signing a personal guarantee for a business debt
As you can see, these go beyond simple mistakes by the owner and are major problems that require accountability to be imposed. For that reason, if you are concerned about whether or not you may face liability for the debts of your business, reach out to a qualified business formation attorney today.