What? You Mean I May Be Liable for Corporate Debts?

2013_03_23__5015If you are a shareholder of Costco or Home Depot, you rest easy when they get involved in lawsuits. You, as the shareholder of a company listed on the New York Stock Exchange, have nothing to worry about because even if these companies lose the lawsuits, you will not be liable for the corporate debt. However, if you are a shareholder of a small business, you need to know how the corporation is structured and managed so that you will not be liable for the business debts.

Why do we form corporations?

Most people form corporations for their business ventures so that they can shield their personal assets. For example, if you operate your business as a corporation, in the unfortunate event that the business sustains a huge debt, the creditor will most likely only be able to recover whatever assets are owned by the corporation. Your house, car, and personal bank account will be shielded from these creditors. Even if your business is crippled by the debt, your personal assets will remain untouched. Most business owners, if not all, receive their financial rewards for taking on calculated risks. Thus, having such security is very important for them.

Are shareholders liable for business debts?

This veil of protection is provided by law to encourage people to take on risks in running their capitalistic ventures. In the eyes of the law, the corporation is a separate entity, that is, it is different and separate from the shareholders. Thus, the corporation is responsible for its debts and not the shareholders. However, this veil is not absolute, and it can be pierced by the creditor if the corporation is not treated as a separate entity.

What?

Well, you are right, in the most part, as the law is intended to be fair. It offers protection for both debtors and creditors. Thus, if you don’t treat the corporation as a separate entity, then your creditors may treat your personal assets as compensation for company debts.

So under what circumstances could this happen?

Well, first of all, the law will not protect you if you set up the corporation to defraud others. Thus, if you set up the corporation as part of a fraudulent scheme, then you cannot use it to shield your personal assets. Sorry, but it’s just fair.

Second, as mentioned above, the law treats you as a separate entity, so you should treat yourself the same. If you don’t, then the law will allow creditors to pierce the corporate veil that was originally designed to protect your personal assets. To make that determination, the court will look at many factors, which I will list in the article that I will post later this week. However, the most important factors deal with how you handle your money. Do you mingle the funds by, for example, treating your company bank account like your personal piggy bank? Do you forgo corporate formalities such as lending money to the corporation without receiving a promissory note from it? Do you take care of the corporate funds as though you are taking care of someone else’s funds by recording how money goes into and out of the business’s account? When established, was the corporation adequately funded to cope with your business venture? If you answered “no” to the first two questions and “yes” to the rest, you are in good shape.

Of course, there are many other factors that the court will consider in deciding whether to allow creditors to pierce the corporate veil. If you wish to know more, you need to consult an experienced attorney who has extensive experience in handling corporate matters. We can inform you of how to set up a corporation correctly, how to manage it, and what corporate formalities you need to observe protect your personal assets from the reach of corporate creditors. Call the Law Offices of Tony T. Liu today to set up an appointment.