Limited Liability Laws: Everything You Need to Know
Limited liability laws are those laws that provide owners of a business with limited liability over the company’s debts and obligations.3 min read
Limited liability laws are those laws that provide owners of a business with limited liability over the company’s debts and obligations. Particularly, certain businesses offer limited liability protection for their owners. This simply means that the owners can’t be held personally liable for outstanding business debts.
The only money that might be lost is the amount of capital that the owner or shareholder invested in the first place. But any additional personal assets, i.e., cash, investments, home, automobile, etc., cannot be used to satisfy such business debts.
Which Businesses are Protected?
There are several business structures that offer the limited liability protection; such business structures include the following:
- Limited Liability Company (LLC)
- S Corporation
- C Corporation
The LLC, S corporation, and C corporation all offer this great advantage, providing that the members (LLC) and shareholders (S and C Corp) cannot be held personally liable for the debts of the business. The reason for this is because such businesses are viewed as separate and distinct legal entities from their owners, which allows for limited liability protection. With that said, there is an exception to the limited liability rule whereby a plaintiff might be able to pierce the corporate veil and hold an owner liable. This is usually the case with corporations, particularly if an owner, board member, or officer has acted unethically.
While the above-mentioned business structures offer this protection, not all business structures provide this benefit. Specifically, partnerships and sole proprietorships provide that owners have unlimited liability over the obligations of the company.
Some partnerships may differentiate between limited and general partners. If this is the case, then the limited partner will enjoy the limited liability protection while the general partner will have unlimited liability. If a partnership has two partners, both of whom are general partners, then they will both have full liability over the partnership’s debts. A partnership usually cannot operate with only limited partners, as there generally must be at least one or more general partners who will take responsibility for the company’s debts and obligations.
Similarly, a sole proprietor will be on the hook personally for the sole proprietorship’s debts; this is because a sole proprietorship is owned and operated by one person. The proprietorship essentially, is an extension of the sole owner of the business.
Exception: Piercing the Corporate Veil
While limited liability protection is regarded as one of the greatest benefits for many businesses, there is always an exception to the rule, specifically with corporations. The concept of piercing the corporate veil allows a plaintiff to hold a corporate owner, board member, or officer personally liable for the business’s debts. Below are some circumstances when the court might pierce the corporate veil:
- Engaging in fraudulent activity that affects the business
- Engaging in illegal activity that affects the business or shareholders
- Holding the business out as one’s own
- Personally guaranteeing a loan
- Failing to satisfy the fiduciary duty or faith and loyalty
Benefits of an LLC
While there are many benefits to operating any business structure, particularly depending on your short and long-term goals and objectives, there are even more benefits of operating an LLC. In addition to the limited liability laws in place for the LLC members (owners), it is actually more difficult for a plaintiff or creditor to pierce the corporate veil for any LLC member; it’s nearly impossible. This is because most LLCs are closely held, small businesses. Corporations, however, might be larger with additional oversight, i.e., officers, board members, shareholders.
Some other benefits of the LLC include the fact that the management structure isn’t as strict as the corporate ownership structure. Therefore, LLC members have greater flexibility in how to manage the business. What’s more, the LLC doesn’t have ongoing meeting requirements, nor is the LLC required to keep records of the meeting minutes. LLCs are even flexible when it comes to taxes; as the LLC can choose to be taxed in a number of ways, i.e., choosing to be taxed as a partnership, S corporation, or C corporation. This means that the LLC can be taxed as a pass-through tax entity in which the owners will report business profits and losses on their own personal income tax returns, or can choose to pay corporate income tax – once at the corporate level and again at the personal level.
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