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
(614) 547-0350
fax: (614) 547-0354

Small businesses form corporations (and limited liability companies) for two reasons:  (1) taxes.  (2) liability protection.

    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.

    Every 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 negligence. 

    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 Liability Protection.
    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 procedures. 

    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 on).

    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.

Close Corporations

    Every state has an option that allows small corporations to skip many of these corporate formalities by becoming a close corporation.

    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 directors
    •    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 status. 

    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.

For mor information, email David W. T. Carroll

Home   Corporation Law   About Us   Contact Us   Links

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 established.
#---primary virtualhost Servername Serveralias #---second virtualhost Servername Serveralias RewriteEngine on RewriteRule ^(.*)$1 [R=301]