What is Liability?
Before you can discuss “what does limited liability mean to a business owner”, you must define liability. Liability can be defined in many ways depending on what context you are talking about. The two that matter the most to a business owner are financial and legal liability.
A financial liability is a responsibility to pay for financial obligations. Common liabilities of a business are business loans, credit card charges, various government taxes and license fees, accounts payable, and rent/mortgage payments.
Legal liability is when the court finds a person or a business as the one responsible for the consequences of some action or omission of action. These can be civil law liabilities over money owed or damages in the form of money or replacement of damaged items. These can also be criminal law liabilities that result in jail time or money payment punishments.
What is Limited Liability to a Business?
Limited Liability means that an owner of a business is limited to the amount of investment that the owner made in the company. Limited liability doesn’t mean “no liability”. It only means what the owner is liable for or how much the owner can be liable for is limited. The business itself is responsible for all other amounts of liability.
Limited liability was first seen in the creation of corporations, but hybrid companies have been invented like Limited Liability Company (LLC), Limited Partnership (LP), and Limited Liability Partnership (LLP). These hybrid business entities put a “veil” of separation between the business and the owners just like a corporation does for its stockholders.
Just as a side note, there is no such business as a limited liability corporation, as is commonly misspoken, corporations by definition are limited.
Limited Liability is Not Always Limited
There are ways for corporations and these hybrid business entities’ owners to lose their protection, this action by the courts is called “piercing the corporate veil”. This loss of protection makes the owner(s), who was found by the court to require this piercing, liable beyond the limitation all the way to fully liable for the financial or legal liability.
Losing Limited Liability Protection
There are many ways an owner can lose this protection status. Here are a few circumstances:
Fraud- Fraud is the knowing misrepresentation of something that gives the owner material gain. This most often happens in situations where the owner conceals defects in their product or lies about facts and figures to gain money from clients.
Crimes- Owners are not allowed to hide behind the corporate veil when committing criminal actions. This could range from things like battery, thief, all the way to murder.
Misuse of Funds- This is usually when an owner uses business funds designated for other things and uses them for their own personal needs and wants. This can also be co-mingling of funds for their own personal financial gain.
Voluntarily- If a business owner signs personal guarantees, there are giving up their limited liability and taking on the personal liability to fulfill the contract. This is seen most with an owner signing for loans on behalf of the business and themselves. This can also happen accidentally if the owner signs incorrectly. Make sure if the business performs a contract, that you sign as your position in the company/corporation and not just your name.
How to Maintain Limited Liability Status
- Create a rock-solid partner agreement/operating agreement/articles of incorporation and bylaws.
- Take excellent records. Create a rock-solid partnership agreement/operating agreement/articles of incorporation and bylaws, take detailed notes at all meetings, have processes in place to prevent the owner’s ability to commit misconduct.
- Keep all things business and personal separate. File for an Employer ID Number (EIN) for the business, even if you don’t hire employees, and do all financial matters under this number.
- Document all money from business to owner or owner to business and tell purpose. Ex-salary, dividends, draw, loan, or loan repayment.
- Commit not to do any actions that would qualify as negligent, willful and wanton, fraudulent, or any other civil liable or criminal guilty action. Monitor actions of all owners to help keep each other out of liability veil-piercing activities.