Choice of Business Entity, Things to Think About – Limiting Your Liability

Some thoughts about the problems small business owners face when choosing a business entity. Among other factors limiting the liability of the business owner must be carefully considered. It is important to remember that simply choosing to do business in an entity – corporation or limited liability company- is not enough to eliminate all the liability the small business owner has.These decisions go far beyond your living plans, states a prominent San Diego Probate Attorney

Small business owners, whether in San Diego or anywhere else in California or in the USA, inevitably give limiting their personal liability as a major reason for choosing a corporation or LLC over remaining or being a sole proprietor. Now I won’t say that this is wrong, but it is hardly fool proof. Remember nothing is as good as good insurance, whether you’re an entity or proprietor.

ate lawyer One of the more exotic exceptions to exemption from personal liability of a small business owner is the prosaic “piercing the corporate veil”. Boy does that sound unpleasant. It is of course, and by the way the limited liability company veil can be pierced on pretty much the same legal principals. At its essence, piercing the entity veil of limited liability is a remedy awarded the business creditor because the debtor business entity has operated in a manipulative fashion that deprives the creditor of its reasonably expected rights to collect its debt. The textbook case involves a business owner/manager, “Mr. Proprietor”, who used of a series of corporations, which owned distinct assets, perhaps different real estate parcels. It is not at all uncommon for investor owners to have a distinct entity for each unique property. Nothing per se wrong with that. Then there will be another entity that is the “management” company. All these business entities were owned by substantially the same person. This person will have all the debt from the operation of the real estate investments or other assets reside with the management company. In other words it manages the real estate or whatever the other entities owned, thereby incurring all the trade debt from operations and liability for personal injury-at least in part-.

As too often happens to small business owners and managers, there was a down cycle and things looked bad for Mr. Proprietor. He shut down the management company leaving a serious quantity of unpaid trade debt. One or more creditors sued Mr. Proprietor and the other entities. The Court found the management company was not a real business. Its only source of revenue was the result of Mr. Proprietor’s exercise of discretion to turn over the rental or other real property income. That effectively made the whole scheme a manipulation of the corporations to deprive the creditors of what they reasonably expected based on the appearance that was held out to them. Mr. Proprietor and the entities that had the assets had to pay the bills.

It is worth noting some things that this case is not about:

• It didn’t exam the corporate formalities or lack thereof. Whether Mr. Proprietor kept minutes of meetings he had with himself is not discussed.

• The case was not decided on the basis of fraudulent inducement, what the creditors know about the ownership of the assets and what Mr. Proprietor knew about their knowledge was not discussed.

• Finally, it wasn’t a transferee liability case. When things go badly it is tempting to transfer liquid or other assets to the owner/managers and leave a depleted shell for the creditors.

That violates a duty the small business owner has to the creditors. The transferee can be held liable for the amount transferred. The owner/manager who makes and implements the decision may be liable for the entire debt owed to an injured creditor. Creditors who are aware of them will often pool their resources to put the entity into bankruptcy and have the trustee recover valuable assets transferred to owner/managers and redistribute them to creditors.

Let’s hope your business is always strong and profitable and you never have to consider the best way to deal with economic stress. But if things go wrong as they often do, you will be well advised to get advice from an attorney with a strong background and understanding of the remedies that a small business creditor has as well as the legal responsibilities of the small business owner and manager.

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