Keeping Your Liability Limited: Rules for Corporations and LLCs

Limited Liability Companies (LLC) and corporations have become indispensable business entities in our society. They allow business owners the opportunity to take business risks without worrying about losing everything they own in the process. This type of protection benefits all of us by allowing enterprising entrepreneurs to offer new products and services by removing their fear of losing every penny they own if the venture fails. For small business and real estate owners, this limited liability protection provides the vital peace of mind that an owner needs to operate their business on a daily basis.

Liability protection does come with certain requirements, however. In order to achieve the asset protection benefits described in my previous article on real estate and LLCs, it is vital that the owner treat the entity separately from his personal or other corporate assets. Additionally, a host of legal formalities should be observed. The failure to do so can make it easier for a creditor to “pierce the corporate veil” and collect against the owner individually or against his other business interests. What follows is a short list of general safeguards which need to be observed in order to reap the rich benefits of limited liability. As always, all individual situations should be discussed with a competent New York attorney.

The first step one takes is preparing and filing the appropriate incorporate/organization documents with the New York Department of State. LLCs, unlike corporations, have a publication requirement which is essentially a gift to the newspaper lobby at the expense of business owners. The law requires LLCs to publish a notice once a week for six straight weeks in two newspapers in the county in which the office of the LLC is located. One newspaper must be printed daily and the other must be printed weekly. LLCs also need to have operating agreements which dictate everything from day to day operations to how the death of an owner affects the LLC. This is especially important for LLCs with multiple members as they prevent one member from selling or gifting his share without the other members’ consents. Operating agreements also discuss the mechanism of how one member can buy out the other members. A corporation needs to have corporate bylaws, which dictate how the corporation is run. Shares of stock need to be issued to all owners, and the corporation needs to have an initial shareholder meeting to vote on directors. Corporations also need to conduct annual shareholder meetings and keep minutes of those meetings.

The corporate entity (other than certain single member LLCs) needs to obtain an EIN number from the IRS and open a separate bank account to transact out of. Corporate bank accounts should not be comingled with personal accounts, and corporate assets should not be used to pay personal debts or debts of other corporate entities. The business should be properly capitalized, and business funds should not be depleted to unreasonable levels. In order to make it clear to the outside world that an owner is acting in his capacity as a member or officer, the official corporate name should be used on all documents followed by the appropriate corporate suffix (Inc, Corp, LLC). All stationary should have the business name and corporate suffix or risk losing limited liability protection. An individual should be careful about not to personally sign on a contract or a lease. Rather, he should sign as an officer or member of the LLC or corporation to avoid personal liability. Although creditors often ask for a personal guaranty, especially when dealing with newer or smaller entities, an attorney should be consulted prior to giving one. I have successfully negotiated away the necessity of such a provision for my clients.

If a business entity is properly formed, segregated, managed, and capitalized, it can provide a tremendous benefit to its owners. The biggest mistake owners can make is managing their corporation or LLC as an alter-ego of themselves. Remember: if you take care of your company, your company will take care of you for years to come.

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