Ask General Counsel: What is my personal liability as a business owner?

Published by Ask General Counsel on InsideNova, 8/11/2021

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Corporations, LLCs, and other organizations are formed to shield their owners from liability. This protection is unique to corporations, as sole proprietorships or general partnerships do not have liability protection; they allow for the assets of both the business and the owner to be seized to satisfy any liability owed by the business to creditors.

The corporation provides assets that cover business costs alleged by creditors, keeping creditors away from the personal assets of the owners.  Corporations generally protect the owner from commercial liabilities (the financial obligations of the business). Commercial liabilities include (1) loans, mortgages, and other debt of the business; (2) income tax and other payable taxes; (3) employee wages and salaries, and (4) personal injuries that occur on the business property.

To an extent, corporations can also shield their owners from tort liability. It is more likely that a small business owner of a corporation will be found personally liable for tortious conduct, regardless of the incorporated status of their business.

Below is a list of legal areas that place personal liability specifically on small business owners, even if the corporation is also liable. Some methods are suggested to help limit any personal liability that may attach to a small business owner, although each method is not necessarily the best fit for every small business owner.

A Small Business Owner is Subject to Personal Liability in The Following Areas:

1. Employment Liability

• The FLSA: Under the Fair Labor Standards Act, a corporate officer may be subject to liability in their individual capacity if they act as a supervisor with sufficient control over the conditions and terms of an employee’s employment. A corporate officer’s liability would apply to any alleged wage or hour violations, such as unpaid wages. A corporate office has sufficient control over an employee’s employment terms when they: (1) have the authority to hire and fire employees; (2) know the recordkeeping practices utilized by the employees; and (3) dictate the policies and expectations in the corporation’s wage and timekeeping practices.
• The FMLA: Courts have held that an employee, and potentially supervisors, may be liable under the Family Medical Leave Act. The FMLA regulations provide that corporate officers, acting in the interest of an employer, are individually liable for violations of the FMLA’s requirements. Small business owners who have authority over FMLA-related matters can be subject to personal liability for FMLA violations. For more information on individual liability under the FMLA for employees and employers alike, take a look at General Counsel’s in-depth analysis of the subject.
• Hostile Work Environment claims: A small business owner could be held liable for an employee’s harassment of a fellow employee if the harasser is the plaintiff’s supervisor or the employer knew or should have known about the harassment and failed to take effective (and recent) action to stop it. Owners faced with hostile work environment complaints should take immediate action on the complaints in order to decrease their risk of being held liable for any claims that arise.
• Owner as an Agent or Employee of the Corporation: Small business owners can be doubly exposed to liability when they commit a tort. Although the corporation may be liable in this situation, the owner is also personally liable to the injured individual.
  There are three situations where a small business owner is personally liable for a tort they committed in their capacity as an agent or employee of the corporation. First, if the owner personally commits a tort, the owner is personally liable for any damages. This phenomenon is common in the personal service business, where owners are constantly interacting with third parties that can lead to tortious claims. Second, an owner who is involved in the hiring or supervisory process of the corporation’s employees can be held liable for negligent hiring or employee supervision. Here, the employee, the owner, and the corporation all face liability for the employee’s actions. Third, an owner can be liable for hiring employees or selling goods in their personal capacity. The owner still is personally liable for acting in their personal capacity, even if the corporation is also found liable in the same case.
  Although it seems like an owner can be held liable for a wide range of employment-based conduct, there are ways to protect an owner from employment-based tort claims.
• Negligent Hiring and/or Supervision of Employees: As stated above, an owner can be liable for their negligent hiring or supervision practices. There are ways to insulate a business’s practices that will lower the chances of incurring hiring and supervisory liability. Some methods include performing background checks and drug tests on candidates to assess the risk they pose for the position. An owner can also implement supervisory techniques, such as a mentoring program and scheduled progress meetings to ensure employees are consistent and timely with their work. These proposed solutions are intended to help owners hire low-risk job candidates. This topic has further been explored by General Counsel here.

2. Tax Liability

• Internal Revenue Code Section 6672: Internal Revenue Code Section 6672(a) imposes personal liability for failure to collect and remit payroll or withholding taxes to the IRS.
  
• Owner as a “Responsible Person”: An owner may be found to be a responsible person and liable for a penalty tax if the corporation fails to pay payroll, sales, or similar taxes. An owner must have a financial duty or responsibility with the entity to be found to be a responsible person.

3. State-imposed Statutory Liability

• Some states only protect owners from the general liability of the company and not the owner’s own acts or omissions. Indiana is one such state; it only protects owners from the general liability of the company, not from the owner’s own actions. A state statute can be silent on the matter, provide a general statement that an owner is not liable for the obligations of the LLC or corporation (the legal norm), or disqualify the owner’s position as a manager of the corporation as a way to hold the owner personally liable for the corporation’s obligations.

4. Profession-based Liability

• In certain situations, professionals that own and operate a business in their profession can be prohibited by law to limit their liability for their acts and omissions, even if their business is operated in the form of a corporation or an LLC. The professional’s liability will be extended to situations where normally the professional would not be held liable. For example, an attorney can be liable in tort for any economic loss arising from the attorney’s negligence, even though they normally cannot be liable for purely economic loss arising in the course of negotiating or performing a contract.

5. Information-based Liability

• Personal Guarantee: Some vendors will conceal personal guarantees in the fine print of their customer agreements, stating that the person signing the form is expressly agreeing to be personally liable, along with the company for all amounts owed to the vendor. Credit card companies are known to do this. Personal guarantees are a massive issue for small business owners especially because they place the responsibility for paying off any outstanding corporate debt on both the company and the owner.
• Creditor’s Notice: A business owner may bear personal liability in a situation if the creditor involved is not aware that the owner’s company is a corporation or an LLC. Simple changes can be made to avoid personal liability due to a creditor’s lack of notice. Using the company’s full name with its corporate or LLC status in its contracts and as a label on all its stationery, business cards, and website, can avoid this issue. For example, “Doe and Sons, LLC” on all business stationery, business websites, and business documents is enough to provide notice to a creditor. It’s also important that any person authorized to enter into a company contract on behalf of the company specifically references their corporate position. Signing “John Smith” on a company contract is not enough to shield Mr. Smith from personal liability; however, signing the contract “John Smith, Managing Partner” is.

 6. Property-based Liability

• Small business owners can be liable for accidents and injuries that occur on their property to third parties. The extent of an owner’s liability differs from state to state. Generally, to be found liable (1) the owner must have a duty of care to the harmed individual; (2) the owner must breach that duty by a negligent act or omission; and (3) the damages claimed must have proximately resulted from that breach of duty.
  General liability insurance covers the expenses of lawsuits that arise in these instances. However, the attorney’s fees and other court costs could go beyond the damages requested. In that instance, the owner would have to pay those outstanding costs.

 7. Personal Liability in the Corporate Context

• 29 U.S.C. § 1109: This section of the U.S. Code places personal liability for misconduct regarding employee benefit plans in a corporate officer’s control.
• Contributions and Distributions
• • Contributions Made by Owner: If an owner is required by the entity’s organizational documents to make a capital contribution, then the owner is personally liable to make those contributions.
  • Improper Distributions to Owner: Distributions to the owner are improper and prohibited if (1) the company would be unable to pay its debts when they are due or (2) the number of the company’s liabilities would exceed the value of its assets.
• Owner’s Participation in Management: Primarily, this applies to limited partnerships. The liability protection of a limited partnership can be lost if one of the limited partners participates in the management of the partnership.
• Piercing the Veil: Piercing the corporate veil is how creditors can legally access the personal assets of owners or shareholders of a corporation. If a creditor can show that the corporation is a “sham”, or not treated as a corporation by the owner, then the court can demand that the personal assets of the owner be used to pay back the creditor. There are various ways to prevent a court from piercing the corporate veil.  General Counsel P.C. discusses these solutions in-depth here.

In conclusion, small business owners can still be personally liable in many situations after they incorporate their business. It is always helpful to consult with an attorney on the liability risks and how best to insure against these risks. General Counsel, P.C.’s attorneys are here to help ensure that small business owners and their companies are covered to the greatest legal extent possible.  If you need assistance, contact us at info@gcpcc.com.