Are You Personally Liable for Your Business Debts?

Edited by Hannah Locklear

Must owning a business mean being personally liable for its debts? Learn steps you can take to avoid putting your personal assets at risk.

The promise of financial reward and personal satisfaction that made you decide to start your own business must be tempered with the realization that you may be held personally liable for its debts. The type of entity or structure that you choose when setting up your business affects the degree to which you may be held responsible for its financial obligations.

A corporate structure, for instance, offers better protection for you from creditors of the business than operating it as either a sole proprietorship or partnership. Even the protection afforded by operating as a corporation can be minimized or lost depending upon how you operate the business.

Before jumping into a new business, get help setting it up from an experienced business law attorney who can help you to choose the best business structure for it. To give you a head start, take a look at some information about business structures and how what you do while running your business can open you to personal liability for its debts.

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What makes an owner liable for business debts?

When creditors attempt to hold an owner personally liable for debts of a business, it generally can be traced back to one of the following circumstances:

• The structure chosen for operation of the business.
• The failure of its owners to follow formalities in the operation of the business.
• The owner intentionally accepted responsibility for the debt.

Sometimes, a combination of these circumstances can lead to personal liability.

How does the type of business structure affect personal liability?

The type of entity or structure chosen for a business affects how it operates on a day-to-day basis, how it is taxed, and, perhaps of most importance for you, the risk of personal liability for its debts. The four frequently encountered types of business structures are the following:

• Sole proprietorship.
• Partnership.
• Limited liability company.
• Corporation.

When you operate a business as a sole proprietor, no separation exists between you and the business. They are easy to set up and operate, but they offer no protection to you against being held liable for business debts. Debts incurred through business activities are your debts rather than being debts of a separate business entity.

Two or more people agreeing to conduct business together is a partnership. Operating as a partnership does not form an entity capable of protecting the partners against personal liability for business debts. However, a limited partnership, which is a special type of partnership, offers some protection to some of its owners.

A limited partnership includes general partners and one or more limited partners. General partners have unlimited liability for business debts, but the liability of a limited partner for business debts cannot exceed the investment made in the business by the limited partner. The tradeoff is that limited partners cannot participate in managing the operation of the business.

Corporations and limited liability companies are different business entities, but each of them protects its owners and their assets against claims by creditors of the business. The protection comes about because each creates a separate entity that owns and operates the business either as a corporation or as a limited liability company depending upon the structure.

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Failing to follow formalities may subject you to personal liability

The protection from personal liability for business indebtedness that you get by operating as a corporation or limited liability company can be lost by failing to follow legal formalities. For example, using business credit cards or funds from its bank account to pay your personal expenses or to purchase things for your home can lead to creditors claiming that you failed to maintain the separation between yourself and the business entity. If a court agrees with them, the separation between you and the business along with the protection against personal liability is lost.

Intentionally making yourself liable for business obligations

A common scenario for a newly formed business operating as a corporation or limited liability company is for landlords, banks, and credit card companies to want at least one of the owners to cosign or guarantee the lease or debt. Accepting responsibility for financial obligations in this manner makes you personally liable for them regardless of the protection you have from the type of business structure.

Things you can do as a business owner to protect personal assets

Reviewing the risks associated with the operation of a planned business venture with your business law attorney helps to determine the type of business structure best suited to protect you from personal liability. Your attorney can review with you the formalities you need to follow to avoid inadvertently losing the protection afforded by the business as a separate entity. Some of the formalities include maintaining accurate records of all business transactions, keeping your personal funds and accounts separate from those of the business, and not using the business as your personal ATM.

Another way to avoid subjecting personal assets to business creditors is to understand the significance of all legal documents that you sign on behalf of the business. Make certain that anything you sign does not obligate you personally by asking your attorney to look at it in advance.

Written and submitted by:
Steve Howards

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