Separating the Company from the Individual
One of the main reasons people choose to form a company is because it gives its owners, managers, directors, and officers limited liability from the debts and expenses of the business. Companies are legal entities and are supposed to be separate and apart from their owners. Companies can own assets, enter into contracts, and are liable for their own debts. So if a company cannot pay its bills, a creditor may only go after the company’s assets. However, unless you are careful about how your company is run, this may not always be the case.
Signing up for Company Debts: There are several reasons that an owner may choose to take personal responsibility for company obligations. If your company is small or a startup, most lenders and landlords will require the owners to co-sign or personally guarantee any business loan or long term lease. Voluntarily agreeing is probably the easiest way to become personally liable for your company’s obligations.
A second, indirect way, is to pledge your personal assets as collateral for a business loan. Often the majority owner of a company will take a second mortgage on their home to get a line of credit for their business. This is often requested if your company does not have sufficient assets to collateralize the loan.
Taxes, Lottery and Other Traps: Certain obligations attach to individual owners or officers either by law or regulation. Under the Internal Revenue Code (IRC) § 6672, an owner may be responsible for failing to pay the IRS various taxes, especially those that are considered to be held in trust by the company, such as payroll taxes. If you have the authority to sign checks, or the authority to hire and fire employees then you may be deemed a “responsible party” for purposes of the IRC and potentially liable for 100% of the unpaid taxes. This responsibility is an individual liability even if you hire someone to handle taxes, such as a bookkeeper or CPA.
Another example of a company liability that can attach to an individual are certain programs that treat an owner as a fiduciary over funds. The sale of Georgia lottery tickets is an example of such an obligation. The Georgia Lottery Education Act, and most likely the contract you signed, establishes a fiduciary duty to the Georgia Lottery, and failure to hand over the funds collected from lottery ticket sales creates personal liability for the business owner. These debts may have to be paid even if the owner declares personal bankruptcy.
Involuntary Liability for Company Debts: Even if you haven’t voluntarily guaranteed a loan or pledged your personal assets, a creditor may hold you liable for your company’s obligations if you didn’t run the company as a separate operation. This is known as piercing the corporate veil. This most often occurs when the company was merely a “shell” and, for all practical purposes the owners used company funds as their personal bank account.
This is a highly fact-specific area of the law, and is determined on a case-by-case basis, but the ones you should be most aware of include whether you followed corporate formalities, whether you commingled personal and company funds, or used company funds to satisfy personal obligations, and whether you sufficiently capitalized your company upon formation. Following corporate formalities, such as holding annual meetings and keeping meeting minutes, are the easiest to accomplish. Although it may seem unimportant, these formalities make your business more legitimate if it is under scrutiny.
Also, if you intentionally misrepresent or knowingly conceal an important fact to a creditor, you may become personally responsible for the damage caused to the creditor.
What Can Happen? Unfortunately, a high percentage of companies fail. If your company fails and you have not maintained the requirements of operating the company as a separate and distinct entity, some of the debts that would have been the responsibility of the company can be attributed to the owners. If the owner decides to file for bankruptcy as a result of the closed business, some of these debts will not be discharged and the owner will be required to make the payments.
The importance of keeping a business entity separate from its individual owners, managers, and officers cannot be overstated, otherwise you risk your home, your savings, and personal property.
Business Insights Business Insights is hosted by the Law Firm of Kumar, Prabhu, Patel & Banerjee, LLC (KPPB).
Hunter Street is of counsel to KPPB Law and is a business, real estate, and corporate lawyer.
Gai Lynn McCarthy is of counsel to KPPB Law and is a bankruptcy lawyer.
Disclaimer: This article is for general information purposes only, and does not constitute legal, tax, or other professional advice.
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