Do I need an LLC or corporation for my new business or is it safe to operate as a sole proprietor? Is purchasing insurance enough protection? If I form a limited liability company or corporation, is it still possible that I can be held liable for something? How can I make my entity “bulletproof?” Will my LLC provide asset protection to me? What can I do to limit my contract liability? If I decide to form a limited liability company or corporation, are there costs or downsides?
These are common questions we get from clients. In this series of posts, we’ll tackle these questions and maybe a few others and try to provide some practical guidance and suggestions.
First, let’s start with a discussion of the sources of liability. There are two basic sources of liability that need to be identified. First, there is contract liability, which arises from the contracts that you or your business enter into with other parties (e.g. your office leases, loan agreements, employment agreements, vendor agreements, etc). With contract liability, only the party to the contract will be held liable absent special circumstances. A simple example is your office lease, if the entity is the party to the contract and doesn’t pay rent, then it is liable for the unpaid rent (and probably other damages) based on the contract. You, however, are not personally liable for the rent, unless you guaranteed the lease or signed it in your individual capacity.
Second, there is tort liability, which is liability arising from the acts of someone. For example, if you are the member of an LLC that owns rental real estate and you personally handle the management of the real estate, then you may be held liable if you are negligent in making repairs which cause harm to a tenant of the LLC. It doesn’t matter that the contract is between your LLC and the tenant, since it’s your personal act that causes the harm and thus you are liable. Another simple example would be your bad driving while on business for the entity that causes harm to someone else. In this case, there is no contract between you and the other driver (or your entity and the other driver) but you are liable anyway. This seems to be a source of confusion for some new clients who mistakenly believe that a limited liability entity protects them from their own acts.
Owners starting new businesses need to think some about the types of contracts and business transactions they will likely enter into and think about the potential liabilities that may arise in the context of their specific business. This should help focus in on the relevant points and help decide if a limited liability entity is needed.
In the next post, we’ll focus more on the questions to be considered when deciding if you need a limited liability entity for your new business or whether insurance may provide sufficient protection.
This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.