Starting a new company and taking risk go hand in hand. Entrepreneurs generally believe that setting up a corporation or an LLC will protect them. But, there are numerous ways that owners, officers, directors and managers can be personally liable, notwithstanding the existence of a separate legal entity.
1. Alter Ego
When an owner of a company does not respect corporate formalities, their personal assets are at risk. Common mistakes include mingling personal and corporate funds, using company money to pay personal expenses, neglecting to contribute capital or issue stock, and failing to hold regular corporate meetings. In these instances, a creditor may try and “pierce the corporate veil” and hold the owner personally liable for a company debt.
To protect your personal assets, only pay yourself a well documented salary or profit distributions and do not use corporate funds to pay personal expenses. Fund the corporation at the outset with capital and obtain insurance. Document annual shareholder/director/LLC member meetings with minutes. Be good about issuing stock certificates and keeping a current shareholder/LLC member register.
2. Employment Violations
Employment violations fall into two categories, discrimination and harassment on one side, and wage and hour violations on the other. Officers and managers can be personally liable for both.
Anyone who harasses an employee may be held personally liable regardless of the employer’s liability. Likewise, anyone who meets the very loose definition of “employer,” which can include officers, directors or managers, can be held liable for federal wage and hour violations. They may even be subject to penalties for violating California’s wage orders.
To protect personal assets, officers and other managers should not only respect employment laws, including classifying workers correctly. They should also get adequate insurance. Insurance will not cover all employment violations. Wage and hour violations are typically not covered. But, discrimination can be, and depending on the circumstances even discrimination in the form of harassment, can be covered.
3. Fraud/Breach of Fiduciary Duty
Directors and officers may be personally liable for fraud if they authorized or directed that it be done. Looking the other way does not work.
Directors, officers and controlling shareholders can be personally liable and are regularly sued for breaching duties to shareholders. San Francisco civil litigator David H. Schwartz offers, “in my experience, when directors and officers have done something that breaches their duty of loyalty and can be characterized as self-dealing, suchs restructuring the company or its capitalization to their own benefit and to the detriment of minority shareholders, they may face exposure to personal liability.” Mr. Schwartz successfully negotiated a settlement on behalf of minority shareholders by marshaling evidence that could show the majority shareholders wrongfully approved a merger in which the officers and directors had undisclosed back-end benefits and misrepresented the terms of the merger to minority shareholders.
The lesson is: Know what the people below you are saying, and get D&O insurance.
Directors, officers and any other employees who are responsible for the company’s payroll or financial affairs may be held personally liable for unpaid taxes. A “responsible” person means someone who has significant decision-making authority over the company’s tax matters.
On the federal level, these taxes could include withholding and payroll taxes. Similar liability attaches for state taxes. In the context of unpaid sales taxes, when a company is terminated, dissolved or abandoned, an officer (or other person who had control over paying a company’s taxes), may be personally liable for willfully failing to pay the tax.
Adam Buttery at the accounting firm of Shea Labagh Dobberstein says, “we see this issue more during periods of economic downturn. Typically it involves business owners with access. They start looking for cash in all possible places, including the wrong ones. All individuals need to remember that once cash is segregated for an employee’s benefit or employment taxes it is no longer the company’s money.”
5. Personal Guarantee
Finally, if you are thinking about personally guaranteeing that lease or line of credit, consider this. Banks regularly pursue personal guarantors on bad debts.
If your company decides to get a lease or business loan, and your company has assets, see whether you can provide the company’s assets as collateral to avoid personal risk.
If you are an owner, officer, director or manager and you have concerns about your exposure, give the attorneys at Wood Litigation, APC a call. We will gladly work through the facts and the issues with you. There is no charge for an initial consultation.