Just about any attorney you ask is going to tell you “yes” you do need limited liability protection that is offered by establishing your business entity as a corporation or LLC. That’s because that attorney would not want to get blamed if he or she advised you otherwise, and you incurred personal liability in the future. While that advice is sound, it is helpful for business owners to examine this issue in more detail.
The reason why choosing a limited liability business entity is a good idea for most businesses is because the owners of that entity will not be held liable for the debts of the business. If the company cannot satisfy its debts, it simply dissolves.
However, just because your company has limited liability, that does not insulate you, as the owner of that company from all forms of liability. For instance, individuals are still liable for their individual misdeeds. The limitation of liability only extends to the company’s misdeeds. If the company enters into a contract and breaches, the company is the responsible party. When an individual is responsible for some misdeed, the company might be liable through vicarious liability, but that does not relieve the individual from being culpable.
Plaintiff’s attorneys will often focus on collecting judgment from the company, because they are more likely to be able to pay. If an individual forms an entity to shield themselves from liability, but ends up being held responsible for a legal action, the limited liability entity will not shield them from judgment. They can dissolve the entity, but will still have to satisfy the judgment.
The limitation of liability also requires certain formalities to prove that a person is not using the company as a shell to shield against liability. One of the biggest factors that courts will look at in making this determination is whether the entity was adequately capitalized or insured. If the company was not adequately capitalized at its inception, or was otherwise used in an impermissible way, the courts will attach personal liability to the owners of the company.
In an overly simplified discussion of this issue, limited liability will protect business owners from personal liability where they were not individually responsible for the legal action and where the company followed the formalities required to maintain limited liability. This is still a great benefit, but it does not come without costs.
All limited liability entities must file paperwork with the Secretary of State and pay filing fees to form. They each have state and federal tax returns to file (though pass-through taxation is allowed) and securities laws may be triggered if any investment money is involved.
For most, the protection a limited liability entity offers is a benefit that outweighs these costs, but for some, the opposite is true. Like any other business decision, fully understanding the costs and benefits of the decision will help you make a determination that is appropriate to your own unique situation.