Incorporating to Avoid Personal Liability

For the small business start-up, one appeal of doing business as a corporation is to limit the owners’ liability. The owners of a corporation – its shareholders – are only responsible for the corporation’s obligations to the extent of their investment: the amount they paid for their shares. The corporation is a separate “person” under the law and responsible for its own obligations: its debts, contracts, regulatory requirements, etc.

Piercing the Corporate Veil

This liability protection is not absolute. A court will “pierce the corporate veil” and impose personal liability on a shareholder where i) the shareholder treats the corporation as his “alter ego”, and ii) upholding the protection would allow a fraud or injustice.

Alter Ego: In deciding whether a shareholder has treated the corporation as his alter ego the court considers whether:

  • The corporation is adequately capitalized
  • Stock was issued
  • Shareholders observed corporate formalities
  • The corporation is solvent: able to pay its debts
  • Officers and directors performed their functions
  • Good corporate records exist
  • The shareholder comingled his funds with the corporation’s
  • Corporate assets were diverted to the shareholder
  • The corporation is a mere façade for the shareholder
  • There is a blurring among the corporation and any related entities

Injustice: A court will not require actual fraud by a shareholder to find that an injustice has been perpetrated on a corporation’s creditors. A court will find an injustice where it believes that upholding the “fiction of a separate corporate existence” would “promote injustice, or promote inequitable consequences.”

Using the Corporation’s Name

Jacksonville law requires that the corporation use its state-filed name when doing business unless it either i) uses an assumed name formally adopted by a filing with the state, or ii) uses a trade name in conjunction with the corporate name.

Because a corporation’s name must include a word or abbreviation identifying it as a corporation (for example, Corporation, Corp, Incorporated, Inc., Limited, or Ltd.) using the corporate name puts a creditor on notice that it is doing business with a corporation and can’t pursue the individuals it is working with personally. If the company doesn’t use its corporate name, a creditor might think the business is a sole proprietorship and that it can pursue the individuals personally for the company’s debts. To protect the creditor from this mistake – caused by the corporation’s use of the wrong name – Jacksonville courts might find shareholders personally responsible.

Conclusion: To maintain the protection from personal liability provided by the corporate form, shareholders must remember to use the corporate name appropriately, to observe corporate formalities, not to treat the corporation’s assets as their own, and to treat creditors fairly.

This article is intended to provide friends and clients with general information regarding the subject matter covered. This article is not, and does not contain legal advice. This article may be considered attorney advertising.

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