The number one reason why we recommend individuals form businesses instead of operating as a sole proprietor or partner is for liability protection. Generally, a member of an LLC or an owner of a corporation will not be personally responsible for the debts and liabilities of the business.
1) If the member or owner signs a personal guarantee. It is very common for banks and landlords to require new business owners to sign a guarantee which “guarantees” the bank or landlord that if the business is unable to pay back the loan or pay the rent, the member/owner will pay personally.
2) If the member or owner is personally negligent. A member/owner can be held personally liable for his own careless actions if he injures someone while operating the business. Professionals can be held personally liable for their own malpractice. This is why we also recommend getting commercial liability insurance. A member/owner can also be held personally liable for conduct occurring outside the scope of employment.
3) If a court “pierces the corporate veil,” meaning the LLC or corporation was merely a shell for the member/owner to carry out his wrongdoing and served no legitimate business purpose. Three elements must be satisfied before a court will hold the member/owner personally liable:
- Control, not mere majority or complete stock control, but complete domination, not only of finances, but of policy and business practice with respect to the transaction attacked so that the corporate entity at the time no separate mind, will or existence of its own; and
- Such control must have been used by the member/owner to commit fraud or wrong, to perpetrate the violation of a statutory or other positive legal duty, or a dishonest and unjust act in contravention of a plaintiff's legal rights; and
- The aforesaid control and breach of duty must have caused the injury or unjust loss. Green v. Freeman, 367 N.C. 136, 145-146 (2013).