Most business owners choose to incorporate their companies as limited liability companies (LLCs) to ensure that in the event of business bankruptcy or indebtedness, their personal assets will not be at risk. An LLC provides this kind of personal protection, unless that protection is lost through one of these five common factors:
Wrongdoing or fraud.
If a business owner or manager has engaged in any wrongdoing or fraud, this can jeopardize the personal liability protection of an LLC. For example, if a business tries to escape its debts by closing down and then reopening the same business under a different name, the business may be engaging in unlawful activity leading to the loss of personal liability protection.
Not maintaining separate identities.
Under the alter ego doctrine, the legal liability protection of an LLC can be set aside by a court if it is found that the LLC was used as a mere shell by persons or other entities for a wrongful or inequitable purpose. If a court finds that the owners of a corporation or LLC used that entity as an extension of themselves or misappropriated corporate assets to enrich themselves, the alter ego doctrine may apply. Some examples of this include when an owner uses company funds for personal expenses or when company property is used to furnish a vacation home.
No operating agreement.
An operating agreement helps establish the company as a separate entity from its members in the eyes of a court. Even if you are the sole owner/manager of an LLC, you should create an operating agreement that details your rights and duties. New Jersey has a statute that acts as a default operating agreement in the event that the LLC does not have one. Despite being provided a default operating agreement by law, it would be a good idea to have an operating agreement that is custom tailored to your LLC.
Undercapitalization.
You must have sufficient assets in a company bank account in order to run your business properly. While undercapitalization in and of itself will not nullify the personal liability protection of your LLC, if there is litigation against the company and it is discovered the business was never properly capitalized, this could lead to the loss of liability protection.
Not following corporate formalities.
Many courts have considered the absence of any company meeting records to be an indication that the entity is being disregarded and will pierce the corporate veil (meaning that your personal liability protection could be lost). There are rules for the proper maintenance of a corporation, LLC or limited partnership that your business attorney can help you ensure you adhere to in order to maintain your limited liability protection.
Johnson Legal PC specializes in business and corporate law and can assist your organization in achieving its full potential. Contact us to learn more about how a great corporate attorney can help your business thrive.
