AllBusiness.com

How Does "Limited Liability" Benefit Corporations?

Buying a Business

One of the key advantages to forming a corporation as your business entity is that if it is properly formed and operated, creditors should not be able to successfully sue the corporation's shareholders for their personal assets. This is what is known as limited liability. If something goes wrong, the shareholders will have only risked what they invested in the corporation and not their personal assets.

Shareholders' personal assets are generally protected from creditors of the corporation. There are, however, certain circumstances in which limited liability may not protect those assets and a shareholder may be held personally liable, including possibly when:

  • There is a disregard of corporate formalities
  • The shareholder personally injures someone
  • The shareholder personally guarantees a bank loan or business debt on which the corporation defaults
  • The shareholder neglects to deposit taxes withheld from employees' wages
  • Personal and corporate assets are commingled
  • The corporation in inadequately capitalized
  • Corporate assets and liabilities are manipulated by the shareholder(s).

Despite the general rule that a corporation's creditors may not sue the corporation's shareholders for their personal assets there are specific circumstances that permit creditors to pierce the corporate veil and satisfy corporate obligations by proceeding against assets of shareholders. Piercing the corporate veil is the exception to the rule, and although it is not often used, it is used in cases of fraud or other wrongdoing. It is used in circumstances where it would be unfair to permit a shareholder to "hide" behind a false or flimsy corporate veil.

While these cases are few and far between and usually involve very bad facts, you should always keep in mind that incorporation of a business does not afford a complete shield against liability for the corporate shareholders. The corporation should be treated as a separate entity, corporate formalities should be followed, and the shareholders, officers, and directors should act in a fair and reasonable manner in accordance with applicable corporate law.