Always Wear Your Legal Scrubs: Protecting Entity Status
Dallas G. Thomsen, LL.M.
Published in the Dove Lewis VetWrap
Generally, protection for owners from the liabilities of the business, limited liability, is the primary reason business entities are formed. The comfort of limited liability keeps many business owners warm at night and operates as an additional level of "insurance." Limited liability is granted automatically by the state on the formation of certain business entities and most business owners would consider it a right. However, most business owners don't know that limited liability can become "un" limited, i.e., lost, if you fail to follow simple formalities and guidelines.
What is limited liability protection?
Generally, limited liability limits your liability for the company's obligations to your capital contributions or investment. Basically, creditors of the company can only look to the assets of the company to satisfy the company's obligations. Limited liability shields your personal assets from the obligations of the company.
Limited liability is an excellent supplement, but is not a replacement for insurance. Limited liability will not protect you from liability from your own individual acts such as malpractice. Veterinarians and many other professionals have additional exposure no matter how well the limited liability entity is formed and operated and are liable for any negligent acts or omissions committed when rendering professional services. This liability can include the acts of partners, other shareholders and employees under the veterinarian's supervision. Nevertheless, limited liability can still protect professionals from a large spectrum of obligations of the company such as contract liability and personal injury not related to rendering professional services.
How do you lose limited liability protection?
You can lose limited liability through some form of a theory called "piercing the veil." Piercing the veil is a legal term used to describe an action to have the entity "set aside" for purposes of the litigation such that personal liability attaches to you, and your personal assets can be reached. The theory is usually used in litigation, where the company is believed to have inadequate assets to cover its liabilities, and the plaintiff alleges that the company is actually a sham, i.e., the company is not really a distinct, separate entity, but is merely an extension or alter ego of the owner, being used to advance the owner's private interests or to perpetrate a fraud.
How do you keep limited liability limited?
The short answer is to follow all formalities and treat the company as a separate and distinct individual. Paying attention to the details is very important.
Keep the company separate
• Do not commingle assets. You should not use the business assets of the company for personal use and you should not use personal assets for business use. Do not borrow the company car to go on vacation. Do not write checks from the company bank account to pay the mortgage on your home or use your personal checking account to buy supplies for the company.
• Carefully document all transactions between you and the company. All contributions, loans, sales and similar transactions should be documented in writing.
• Make sure all transactions between you and company are arm's length. In other words, treat transactions between yourself and your company as if you were transacting with an unrelated third party. Charge interest on loans, buy or sell goods at the prices you would charge customers, and do not give yourself any special deals you would not give to a regular customer.
Follow the formalities
• Operate the business of the company as the business of the company. The company should purchase equipment, borrow money, enter into leases and engage in other business transactions, where possible, without the individual endorsements of the owners of the company or of individuals employed by the company. The owners and employees should sign documents on behalf of the company in a representative capacity. Sign the documents as president, shareholder, member, limited partner, etc.
• All meetings of the owners, shareholders, members, partners, directors, managers, etc. should be recorded in writing. If the entity is a corporation, make sure annual meetings are held and the minutes are recorded. Other types of entities should consider holding similar meetings, even though it may not be required, in order to show the company is following the formalities. If you hold a meeting, write it down.
• Operate the company administratively as separate from you. Set up separate checking accounts in the name of the company, use the company's employer identification number for all tax purposes, insurance policies of the company should be purchased in the name of the company, taxes on wages paid to employees of the company should be withheld by the company, etc.
• Assets of the company should be in the name of the company. Assets used in the business of the company should generally be owned in the name of the company. If the company uses it, it should own it. There are exceptions such as assets leased or rented by the company. For larger assets such as real property, you should consult with an attorney to determine the best ownership.
Treat every transaction with your company as if you are working on a patient. Protect yourself as well as your patient, the company, by keeping a separate and "sterilized" environment where your business and personal affairs do not mix. Update your file every time you have an appointment with your client, i.e., document in writing every transaction and meeting. With regular maintenance, your company can have a long and productive life of protecting your person assets from business obligations.
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