Last updated May 30, 2017.
Whether or not you are personally liable for the debts of your business depends on two factors:
- the structure of the business that you own and;
- the contract you signed with your lender. As a practical matter, many lenders require the business owners to personally guarantee business debts regardless of entity choice.
Nevertheless, we will delve into the liability implications of various corporate forms below. Your business may be structured as a Sole-Proprietorship, a Partnership (there are multiple forms of partnerships), a Limited Liability Company (LLC), or a Corporation. Each of these types of business entities, and the amount of personal liability associated with them, will be explored.
Am I liable for the business debts of my sole proprietorship?
If you are the only owner of your business, and you have not organized your business as corporation or a limited liability company, then you are likely a sole proprietor. The default setting for a sole proprietorship is full liability. If you take on debt as a sole proprietor, you owe it in your name. You’re fully responsible for paying it back, and in the event of default, your assets are potentially vulnerable. Therefore, if your business is in debt and owes money to creditors, those creditors may come after your personal property to satisfy the business debt.
What about the debts of my partnership?
For our purposes, it’s best to think of a partnership as a group of sole proprietors working together. Like a sole proprietorship, the default setting for a partnership is full liability, however, there are types of partnerships that offer limited liability. The different types of partnerships, and the liability associated with each is discussed below:
A general partnership is the default form of partnership. If you and at least one other person agreed to own a business together, and didn’t form a business entity, then you formed a general partnership. In this type of business, each partner is considered a general partner, and each is liable for ALL of the debts of the business, not simply their fair share.
A limited partnership consists of one general partner and one or more limited partners. Only the general partner is personally liable for the debts of the business. Limited partners are not liable for business debts. If your business was created with an agreement that one partner would absorb all liability for the business, then you probably have a limited partnership.
Limited Liability Partnership (LLP)
Depending on what state you live in, you may be allowed to organize your business as a limited liability partnership. In an LLP, all of the partners are protected from personal liability for the debts of the business. Thus, creditors may only take the assets of the business to satisfy a debt, and may not come after the personal assets of any of its owners.
Can shareholders be liable for debts?
Technically speaking, corporations are entities designed to limit the liability of their owners. A corporation is owned by its shareholders, who are protected from liability for the debts of the corporation. Hence, if a corporation is in debt, the creditors of that corporation may only come after the assets of the corporation, and the property of the shareholders cannot be touched. If you incorporated your business by filing as a corporation with the state, then your business is a corporation.
However, there are situations in which the creditors of a corporation may collect a business debt from shareholders. Examples of such situations include:
Cosigning a Business Debt
If you cosign or personally guarantee a debt of the business, then you are equally liable to creditors. By cosigning or offering a personal guarantee, you have volunteered to be responsible for business debts.
Piercing the Corporate Veil
“Piercing the corporate veil” is an expression used to describe when the creditors of a corporation may come after its owners (the shareholders) to pay its debts. The corporate veil may be pierced, and the shareholders may become liable for business debts under a number of circumstances, some of which include:
- Failing to obey corporate formalities: Corporate formalities include things that are legally required of a corporation such as holding meetings of the board of directors, or holding annual elections for directors.
- Commingling of funds: If shareholders, as the owners of a corporation, have contributed much of their own funds, and also use the funds of the corporation as if they were their own, then a court may find that your funds are one in the same and may hold you personally responsible for the debts of the corporation.
- Fraud: If the corporation is found to have committed some sort of fraud by acting through its owners, then the shareholders may be held personally liable. An example of fraud may include, among other things, any falsification found on an application for a business loan.
Who is responsible for limited liability company debts?
Owners of a limited liability company (LLC) are commonly called “members,” and only stand to lose the amount of money that they contributed to the business. Therefore, creditors of an LLC may only take the assets of the LLC entity to satisfy a debt, and they may not come after the members’ personal property.
However, just like with a corporation, creditors may come after members’ personal assets in a number of situations. Therefore, if you have personally guaranteed a business debt or cosigned on a business debt, then you are personally liable for that debt. Moreover, creditors may be able to “pierce the LLC veil.” Thus, if there has been a failure to obey legal requirements, or any type of fraud, then you may have exposed yourself to personal liability.
Protect Yourself and Your Business: Consult with a Bankruptcy Attorney Today
It is important to understand that a person may never be 100% immune from liability for the obligations of their business. Therefore, you should consider speaking with an attorney if you have concerns that you may be liable for the debts of your business.
This post is intended as a basic overview of business liability issues, both in Ohio and nationwide. For more information on Ohio laws concerning LLC liability, take a look at this informative post by Worley Law.