Starting a company is hard work. Keeping it going is even harder. Most people don't stop to consider why they formed a company in the first place. To protect themselves from personal liability for company related actions. LLC's, Corporations, and Limited Partnerships all exist for the same reason. To allow individuals to take risks, without putting their entire lives at stake. Some people fail to realize that if they aren't careful, they could become personally liable for company issues very quickly. For an overview of Piercing the corporate veil more generally, simply click the link.
Alter Ego Legal Doctrine
Step into your first business law course, and within the first week, you will likely encounter this legal doctrine that can have devastating impacts on the personal lives of business owners everywhere. While the functionality of the doctrine varies slightly by state, in general, the concept is simple. If it can be shown that the identity and out-workings of company are so closely tied to the identity and activities of its owner(s), one or more of the owners could be held personally responsible for company actions. Now you are getting ready to ask me a very valid question,
What does that mean?
When a company gets sued, more likely than not, the injured parties attorney will attempt to pierce the corporate veil in order to attach the owner(s) assets, even if it is another corporation. This is especially likely in situations where the company being sued is very cash poor, or otherwise "judgement proof", while the owner(s) have plenty of liquid assets at their disposal.
Give me an example!
Mr. John Doe is an exceptional entrepreneur! On the advice of a friend, who told him all about "Shell Companies" he decided that he would start a corporation. And so he did! He started Company "A". He was the sole owner, and followed all of the appropriate rules for effectively forming the company. Company "A" is an office supplies company that supplies local businesses in the local area.
Seeing that his business was expanding into other regions of the state, and desiring to limit his potential personal and business loss exposure related to a law suit, Mr. Doe decided he would create Company "B". Company "B" was to serve ONLY the interests of a much smaller, 50 square mile region within the state. Company "B" was properly formed, had a name not easily identified with Company "A" and was owned 100% by Company "A".
Later, realizing that staplers were perhaps the most dangerous item his companies sold, Mr. Doe surmised that if he formed a stapler company (Company "C"), and only sold staplers through that company, that in the event of a law suit, only the assets of Company "C" could be attached, and ultimately lost if the suit was successful. Company "C" was properly formed, had a unique name, and was 100% owned by Company "B".
Then... One day, a lawsuit is filed by Patty Plaintiff! The lawsuit alleges that Company "C" is responsible for the manufacturing of an inherently dangerous product that caused $1,000,000 in damages to an individual whom was injured while using the stapler in its proper manner. In addition to holding Company "C" responsible, the law suit also alleges that Companies "B" and "A" should also be held responsible as Company "C" is a mere instrumentality or alter ego of "B" and "A". What will happen?
If the facts of this case are exactly as they've been stated, there is a good possibility that at the very least, the assets of Company "B" will be at risk in the event Patty Plaintiff is successful in her case. There is a good possibility that the assets of Company "A" would be at risk as well. Effectively, Mr. Doe set up multiple companies, each of which was a different version of Company "A". The companies served the same customers, perhaps shared some key, executive level employees, and Company "C" only operated for the purpose of insulating the company from potential liability for its most dangerous product.
While Mr. Doe may not be held personally responsible under the lawsuit, the assets of his companies are certainly at risk. Despite his seemingly intelligent plan, he did not effectively mitigate the risks he thought he was.
How do you know if you're protected? First, use an attorney to help you properly form your new business. Be sure to let the attorney know about all of the risks the company may or may not be taking in the course of doing business. Second, know your options when it comes to insurance. There are a variety of different policies available to help mitigate some of your business risks. Finally, if you are already operating a business today, don't assume that you did it right. Schedule a FREE CONSULTATION with an attorney and make sure you have positioned your company for success, and protected yourself from personal liability.