One of the main reasons people form a corporation or a limited liability company (LLC) is to limit their personal liability for company debts. However, there are many ways to become responsible for company debts. Read on to learn more about when you might be held personally liable for debts incurred by your corporation or LLC.
(To learn more about LLCs and corporations, see Nolo's Business, LLCs & Corporations Center.)
Overview of Corporate Limited Liability
When you form a corporation or an LLC it becomes a separate legal entity apart from its owners. This means that the business itself can own assets, enter into contracts, and is liable for its own debts.
If the corporation or LLC cannot pay its debts, creditors can normally only go after the assets owned by the company and not the personal assets of the owners. However, the business owner can also be held responsible for corporate or LLC debts in certain situations. Below, we discuss how this can happen.
Cosigning or Personally Guaranteeing Business Debts
If you cosign on a business loan, you are as equally responsible as the corporation or LLC to pay it back. This is usually the simplest way to voluntarily make yourself liable for your company’s debts. Similarly, if you personally guarantee an obligation of the corporation or LLC then the creditor can come after your personal assets if the business defaults on the loan.
Pledging Your Property as Collateral
If you have a new company or your company does not have many assets, a creditor may require you to provide some sort of collateral before approving the loan. If you agree to pledge your house or other personal assets as collateral for the business loan, the creditor may be able to take your property and sell it to satisfy the obligations of the company.
Piercing the Corporate Veil
Above we discussed the ways you can voluntarily make yourself personally liable for a corporate or LLC debt. However, a creditor can also try to go after your personal assets by eliminating the limited liability protection provided by the corporation or LLC. This is commonly referred to as piercing the corporate veil.
The corporate veil is usually pierced if the creditor can show that the corporation or LLC was a shell created only to provide liability protection for its owners or the company was practically inseparable from or an alter ego of its owners.
Courts will be more likely to pierce the corporate veil if:
- Corporate formalities, such as holding annual meetings and keeping minutes, were not followed.
- Certain owners exerted too much control over the corporation or LLC.
- Owners commingled personal funds with company funds or used personal funds to satisfy company obligations.
- The company was not sufficiently capitalized when it was formed.
(To learn more, see Piercing the Corporate Veil: When LLCs and Corporations May Be at Risk.)
A corporation or LLC’s owners may also be held personally liable if they are found to have committed fraud. If the owner made fraudulent representations or omissions when applying for a business loan, he or she can be held personally responsible for the resulting harm to the creditor and risk losing personal assets. Alternatively, if a corporation or LLC was created to further a fraudulent cause or business, a court can pierce the corporate veil to get to the owners as well.