Sometimes, you can become personally liable for the debt of your corporation or LLC. Learn how this happens.
By Baran Bulkat, J.D., California Western School of Law
Oneof the main reasons people form a corporation or a limited liabilitycompany (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 fordebts 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 legalentity apart from its owners. This means that the business itself canown assets, enter into contracts, and is liable for its own debts.
If the corporation or LLC cannot pay its debts, creditors cannormally only go after the assets owned by the company and not thepersonal assets of the owners. However, the business owner can also beheld 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 asthe corporation or LLC to pay it back. This is usually the simplest wayto voluntarily make yourself liable for your company's debts.Similarly, if you personally guarantee an obligation of the corporationor LLC then the creditor can come after your personal assets if thebusiness defaults on the loan.
Pledging Your Property as Collateral
If you have a new company or your company does not have many assets, acreditor may require you to provide some sort of collateral beforeapproving the loan. If you agree to pledge your house or other personalassets as collateral for the business loan, the creditor may be able totake your property and sell it to satisfy the obligations of thecompany.
Piercing the Corporate Veil
Above we discussed the ways you can voluntarily make yourselfpersonally liable for a corporate or LLC debt. However, a creditor canalso try to go after your personal assets by eliminating the limitedliability protection provided by the corporation or LLC. This iscommonly referred to as piercing the corporate veil.
The corporate veil is usually pierced if the creditor can show thatthe corporation or LLC was a shell created only to provide liabilityprotection for its owners or the company was practically inseparablefrom 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.)
Fraud
A corporation or LLC's owners may also be held personally liable ifthey are found to have committed fraud. If the owner made fraudulentrepresentations or omissions when applying for a business loan, he orshe can be held personally responsible for the resulting harm to thecreditor and risk losing personal assets. Alternatively, if acorporation or LLC was created to further a fraudulent cause orbusiness, a court can pierce the corporate veil to get to the owners aswell.
