Caution:  The following identifies some basic but highly technical  issues. It seeks to summarize a very broad subject in about 500 words. There are many exceptions  and nuances to these rules, so if you think you have an issue, consult your attorney.

 Many small businesses operate as either sole proprietorships or loosely formed ‘partnerships’ without giving much consideration to the risks those forms of business entail.  When operating through either of those business entities, the owner is individually responsible for all the debts, losses and liabilities of the enterprise. To avoid this, you can incorporate and protect your personal assets, leaving only your corporate assets at risk. The cost of incorporating is minimal when you consider the risks you avoid by forming and operating as a limited liability entity.  If  you have something worth protecting (which is, after all, the point), you should carefully consider one of the forms of business entity that limits your exposure:  a corporation (either a “C” or an “S”) or a limited liability company (each a “Limited Liability Entity”).

It is important to recognize that an Limited Liability Entity has a separate legal existence, which is why the individual owner who follows the rules is not liable for its debts and obligations, unless, of course, the owner voluntarily guarantees those obligations (as often happens when a bank loans money to the enterprise).

Having said that, there is a doctrine called “piercing the corporate veil” which applies when the owner fails to observe the rules governing these entities.  Courts apply what is referred to as the "alter ego" doctrine to determine whether the Limited Liability Entity’s identity should be disregarded and liability should be placed on the owners. The alter ego doctrine provides that the ‘corporate veil’ may be pierced when:

 1.     There is such a ‘unity of interest’ between the owners and the Limited Liability Entity that the distinction between them does not in reality exist (e.g., the owners fail to maintain separate bank accounts and intermingle the corporate assets with their own); and 

2.     Recognition of the shareholders and the Limited Liability Entity as separate entities would be inequitable (e.g., where the entity is insufficiently capitalized to pay its foreseeable obligations or where the owners don’t make it clear to the outside world that they are doing business with a Limited Liability Entity). 

The application of this doctrine is highly technical and its details are beyond the scope of this month’s article, but the point is that merely forming the Limited Liability Entity will not suffice:  the owners must follow the rules on an ongoing basis or risk that the protections they sought have evaporated.

(Jay Strauss is a practicing attorney, a former Chamber of Commerce President (1994) and former Mayor of Lafayette (2000).  He can be reached at jstrauss31@yahoo.com.)