Choosing the legal structure of your company is one of the most important decisions you will make when starting your business. The type of business structure you choose helps determine your level of liability for corporate debts. Corporations, limited liability companies, limited liability partnerships and other forms of businesses can offer protection from lawsuits and other debts according to your state’s laws, but such protection can be limited or nonexistent under some circumstances.
Generally, a corporate officer’s personal assets are not vulnerable to pay corporate debts. This means a corporate officer is not typically required to pay business debts with his own money, although he could lose the money he has invested in the company itself. Since a corporation is an independent legal entity, this type of protection extends to both officers and shareholders, protecting their personal assets from things that might go wrong with the company. To obtain these protections, you must ensure that you have incorporated your corporation properly under the laws of your state and you must file all required paperwork, such as annual corporate reports.
The general liability protection the corporate structure provides may not apply to officers if the officer is being sued for some specific act. For example, if you deliberately conceal facts that you are otherwise required to disclose to a federal regulator or shareholder, the law could hold you personally responsible. In some states, your actions on behalf of the corporation are protected if you used reasonable business judgment, even if it turns out later that your decision cost the company money. This protection, however, depends on state law. In some states, like California, it is not clear from existing law whether the business judgment protection applies to corporate officers or only to corporate directors.
Piercing the Corporate Veil
Officers who are also shareholders of the corporation may be held personally liable if the corporate structure is not preserved. This is particularly common in small corporations where a handful of people act as officers, directors and shareholders. If your corporation does not observe corporate formalities like having annual meetings, making decisions according to your corporate bylaws or keeping corporate and personal assets separated, you could be held personally liable for corporate debts in a lawsuit. The person suing you could ask the court to look past the formal corporate structure, which is called “piercing the corporate veil,” to determine if the business structure is merely a sham.
In the Articles of Incorporation, companies can agree to indemnify, or protect, their officers or other employees if they are sued for actions they took on behalf of the corporation. Corporations can even purchase liability insurance specifically to cover costs of lawsuits against their officers and directors. However, these indemnification clauses and policies may have restrictions that make them inapplicable in certain situations. For example, a clause that protects a current officer may not protect him if he resigns his position or moves to another company.