Why a Corporation Might Not Protect Your Assets

I listen to satellite radio, and there’s all sorts of advertisements for “incorporation services”.  Invariably, one of the selling points is that by incorporating you can “protect your assets”.
There are several types of “limited liability entities”, basically setting up some sort of entity that holds title to a business, that are supposed to provide protection to the owner of the entity.  Common examples include Corporations, Limited Liability Partnerships, Limited Liability Companies, and some specialized business models, such as Illinois Land Trusts and Professional Associations or Professional Corporations.   I’m going to refer to all of these, generically, as Corporations.  While there are significant differences between them, the basic theory is this: the Corporation or LLC owns the assets of the business; real estate, vehicles, inventory, equipment, whatever, and the corporation is the legal entity that is in the business; the corporation has its’ own EIN, files taxes, issues the paychecks, enters into contracts and otherwise has an independent existence.  The people who own the corporation cannot be sued for something that the corporation does wrong; if the corporation damages someone, the corporation has to be sued and not the individual owners of the corporation.  And I’ve seen some fairly elaborate tiered structures; one corporation owned by another corporation, which is owned by another, and after several layers of corporate ownership, then you get to real, live, human, owners.  In theory this provides multiple layers of protection, and the most anyone can lose is what they have invested in the corporation.
That’s fine in theory.   And, to the extent that you have a large corporation, with multiple owners and multiple operating locations, that’s accurate.  If Ford Motor Company does something wrong, you sue Ford Motor Company, not the individual stockholders of Ford. The problem is, for most small businesses, the owner or owners are involved in the day to day running of the business.  And even if you have a corporation, if  you are involved in running it, then you can always be sued for what you, personally, did or did not do.
The clearest example I can give is the owner of a corporation driving a corporate owned truck, who gets into an accident and hurts or kills someone.  It doesn’t matter that the truck was owned by the corporation; the owner was driving the truck and can be sued because they were driving the truck.  You were driving the truck, you failed to yield at a stop sign or blew through the red light, or whatever, and caused the accident and hurt someone. You’re going to be sued; saying that the truck was owned by the corporation and you were on corporate business simply isn’t going to help you.
Even if you were not the person who actually caused the damage, if you were involved in the running of the business, there’s a good chance that you could still be sued, personally.  If one of the employees of the business hurts or kills someone, you are likely to be sued under a theory such as “negligent hiring” “negligent supervision” or “negligent retention”, Basically, these theories say that you, as the manager, president or CEO of the corporation hired this person, gave them the keys to the truck, or put them in a position to do damage to someone else. If you’re running a bar that is owned by the corporation, and your bouncer beats someone up in the parking lot, you’re going to be sued on the theory that you were the guy who hired the bad bouncer and didn’t make sure that the bouncer didn’t get out of hand.
Understand, I’m not saying that a corporation doesn’t provide any protection; it provides some; but too many people have the impression that limited liability entities are bulletproof in terms of providing personal protection; they are not bulletproof.  If you are involved in the business, and something happens that causes enough damage, there’s a good chance you are going to wind up being sued.
So, what can you do about this?  You can get insurance.  I do not like to sound like shill for the insurance industry, but for most types of businesses, insurance is relatively cheap.  If you own or operate motor vehicles, you need automobile insurance; with a sufficiently high policy limit.  How much is that?  Talk to your agent, typically high limit coverage is not that much more expensive than lower limit coverage.  I don’t think that a million dollars coverage is too high.  And, you need liability coverage for your business; this is a separate policy from the auto insurance. This should cover anything that happens outside of a motor vehicle; if someone slips and falls at  your office, if one of the employees punches out a customer, liability coverage should step in and cover you for this.  Once again, how much coverage?  Talk to your agent.  And, you might want to talk to your agent about something called an “umbrella policy” which basically steps in and covers you if the damages exceed your  limits under your ‘regular’ insurance.  Umbrella coverage is relatively cheap as well.

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One Response to Why a Corporation Might Not Protect Your Assets

  1. Mo says:

    Ronald,
    I have always told clients to have both while always taking care to carefully explain the various kinds of entities and placing the proper amount of emphasis on “limited liability” for the corporate and LLC forms. But to your point, my first recommendation is always for them to get liability insurance and then proceed to the business entity formation.

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