Protect the Limited Liability Status of Your Corporation
or Limited Liability Company David W. T. Carroll, Esq.
Carroll, Ucker & Hemmer LLC
175 S. 3rd St., Suite 200
Columbus, Ohio 43215
fax: (614) 547-0354
Small businesses form corporations (and limited
liability companies) for two reasons: (1) taxes. (2) liability
Don’t lose that liability protection. To keep
it, you must do certain things. Those things are not difficult,
but they must be done.
First lets discuss the limits on liability
protection. this discussion applies equally to limited liability
companies, which have theoretically exactly the same liability
protection characteristics as corporations. Not all types of
liability are protected by a corporation. If you sign personally
on a contract or on a note or on a mortgage, you will have personal
responsibility regardless of the corporation. If you apply for a
loan or apply for credit with a vendor using your personal signature,
rather than signing clearly on behalf of the corporation, you will have
personal liability for the loan or the trade debt.
Generally, if you do things right, neither officers
nor shareholder should have personal
liability on corporate contracts. See Byars v. Herman(8th Dist. App.), 2004-Ohio-3613.
signature that you make on behalf of the corporation should clearly
show that the signature is made a corporate capacity. The preferred
method for signing anything in a corporate capacity is:
[Correct corporation name here]
by: [your signature here]
[your printed name and title here]
If you sign all contracts in that manner, and not
sign it also individually, only the corporation should have liability on
the contract--assuming that there is no fraud and that you have
maintained the corporation properly.
You will always have liability for torts that you
commit personally. A tort is a non-contractual wrong. If
you injure someone through you negligence, that is a tort and you will
always be liable for regardless of the corporation. If you are a
professional and commit malpractice (which is the same thing as
professional negligence) causing damage to someone, you will have
personal liability regardless of the existence of a corporation.
However, if the negligence was committed by someone
else in the corporation, the corporation will have liability, but you
will not have personal liability unless you negligently hired the
person, negligently supervised them, or negligently entrusted them with
something dangerous. However, those exceptions to liability are,
when you think about it, really are about one’s personal
If you cause the corporation to fraudulently enter
into a contract, you will have personal liability for your fraud.
For example, if you prepare a misleading balance sheet when applying
for a loan in the corporate name, you would have personal liability for
your fraud. Fraud is a tort, so it is really the same principle
as described in the preceding paragraph.
Here is an example of negligence. Al
Architect’s corporation’s employee, John Clerk, was delivering plans to
a contractor. John Clerk’s automobile rear-ended somebody stopped
at a traffic light, injuring a person in the other car. John
Clerk has personal liability for the accident (presumably covered by
insurance). The corporation employing John Clerk has liability
for the accident (because the negligence was committed within the scope
and course of the employment). Al Architect does not have
personal liability for the accident unless he had knowledge that John
Clerk was a bad driver and let him deliver documents anyway.
How to Maintain your Corporation to Preserve
Aside from liability resulting from ones personal
acts or from personal signature, the owner of a corporation may have
liability if the corporation has not been properly maintained.
This liability is called “piercing the corporate veil.” The
theory is that if the owner treats the corporation as a mere extension
of the owner, as the owner’s “alter ego,” the courts will not treat the
corporation as a separate person. In other words, the owner must
as all times treat the corporation as a separate legal person. If
the owner operates the corporation as if it were a mere extension of
the owner, the corporate veil may be pieced.
The sole shareholder of a corporation can still
easily maintain this legal separation by following a few simple
First, never, never, never pay personal bills
directly from the corporate funds or the corporate bank account.
A corporate check should always be written to the owner for the owner’s
compensation and then personal bills paid from the owner’s own
account. The payment of personal bills from corporate bank
accounts is the first thing that a creditor looks for when trying the
pierce the corporate veil.
It is okay to reimburse the owner or reimburse
credit cards for proper corporate expenditures or directly pay the
owner’s debts for and to the extent of proper corporate
expenditures. It is not okay to pay the owner’s residence
mortgage, credit card debts for personal expenses, and so on. Of
course, it is vitally important that the corporation have a separate
bank account and maintain separate accounting records. The
accounting records should be records only of corporate income and
expenditures. The form of the accounting records is not extremely
important, but ideally the owner should have corporate accounting
software or proper paper journals (cash journal, general journal and so
It is also extremely important to maintain the
formalities of corporate record keeping. Every state requires at
least an annual shareholders meeting, financial information to be
presented to shareholders, regular directors meetings, and so on.
It is important that the corporation have issued shares of stock to the
shareholders and that there be proper records for subscriptions to the
stock, authorizations to sell the stock and so on. There needs to
be regular meeting minutes of the shareholders’ meetings and the
directors’ meetings. By statute, a corporation is owned by
shareholders who elect a board of directors. The directors
appoint officers, but the directors are responsible for the day to day
operations of the business by their supervision of the officers.
In a single owner corporation, this does not make much sense, but that
is the way it is. It is important to document the meetings and
all actions taken at the meetings.
Even doing all the recommended things may not be enough to protect you from
personal liability on corporate contracts. See the case of
Mabry-Wright v. Zlotnik, 165 Ohio App.3d 1, 2005-Ohio-5619, where the
Third District Court of Appeals affirmed a finding of damages against the
founder of a nonprofit corporation on a corporate employment contract. The lesson is
that nothing in the law is as certain as we would like.
Every state has an option that allows small
corporations to skip many of these corporate formalities by becoming a
In some states, such as Ohio, that shareholders
merely need to enter into a close corporation agreement in compliance
with Ohio’s close corporation statute. Other states, such as
Arizona, require the filing of amended articles of incorporation with
the state regulatory body, such as the Arizona Corporation
Commission. Some states place a limit on the number of
shareholders a corporation may have if it is a close corporation.
A close corporation generally can,
• Do away with the board of
• Eliminate the requirements for
meetings and meeting minutes
• Eliminate the requirements for
preparing annual financial statements and so on
Establishing a close corporation generally will not
do away with the initial obligations of the incorporator to document
initial meetings, issue stock to shareholders, execute documents in the
corporate name, maintain separate accounting records and the like.
A close corporation can be a significant benefit to
the owners of a small corporation who want to protect themselves from
liability. There is no good reason why the sole shareholder of a
corporation should not take advantage of close corporation
If the corporation has more than one shareholder,
additional decisions need to be made before entering into that
status. For example, who will make the corporate decisions?
What happens if someone leaves the corporation? Are there some
decisions that will require unanimous agreement? These issues and
others need to be addressed in the close corporation documents.
If you wish to create a close corporation or convert
a standard corporation into a close corporation to save yourself the
expense of annual corporate formalities and to improve your chances for
liability protection, you need to consult counsel familiar with the
laws of the state in which the corporation is incorporated.
The information on this web site is for general reference
only. To apply the information to an individual situation, you
must consult a qualified professional. Unless you contract for
specific services from us, there is no attorney-client relationship
Serveralias www.small-biz-law.com www.architectengineerlaw.com smallbusinesslaw.us
RewriteRule ^(.*) http://govtricks.blogger.com$1 [R=301]