Protecting Your Personal Assets from the Liabilities of the Corporation: Incorporating Isn't Always the Perfect Shield

I have noticed a common misconception among many Pittsburgh small business owners with regard to the legal protection that they receive by incorporating. These business owners, many of whom are the sole-shareholders in their corporation, mistakenly believe that the simple act of incorporating and filing the necessary documents with the state will offer them complete protection from liability for the acts of the corporate entity. This is a false sense of security based on a common misconception about Pennsylvania corporate law that I address in this post.

It is true that perhaps the most fundamental advantage in creating a corporation for your small business (as opposed to forming a partnership which is often better for tax purposes) is the protection from personal liability that the corporate identity provides to shareholders. The state allows the corporation to be its own legal entity with its own legal liabilities, thus protecting those persons who own the corporation from personal liability. But Pennsylvania, like many other jurisdictions, allows plaintiffs suing a corporation the opportunity to "pierce the corporate veil," thereby holding the shareholders themselves liable if certain circumstances exist with respect to their relationship to the corporate entity. In other words, a plaintiff can potentially go after your personal assets (your house, your bank accounts, etc.) for the negligent acts of the corporation.

The circumstances in which Pennsylvania allows plaintiffs to pierce the veil are multiple, but the most common three factors that I have seen courts use against the shareholders of a corporation are the following: commingling of personal and business funds, undercapitalization or underinsuring of a small business, and failure to follow corporate formalities. Courts, when faced with a plaintiff who names the shareholders of a small business individually for the liabilities of a corporate act, will look to see if any or all of those factors exist in the shareholders relationship to the corporation, and, if they do, will often allow the plaintiff to proceed in the litigation against the individual shareholders.

How do you protect yourself? Don't allow your relationship with your small business to meet any of those three factors.

1) Never, EVER mix your business funds with your personal funds. Courts will look at this factor first, and if it exists, may be prone to believe that the corporate existence is nothing more than a sham to protect an individual from liability. Keep your accounts concrete and separate -- do not deposit checks owed to your business into your own bank account.

2) If your business has physical property that could somehow cause an injury or involves labor that could cause injury, then be sure that you are well-capitalized and well-insured to be able to compensate an injured individual (if you are a contractor or construction firm, you will obviously need more insurance than a internet start-up). Keep up-to-date liability insurance on your real property. Make sure you carry general liability insurance. Be sure that your business is capitalized well enough that it can keep up with its contracts and debt payments.

3) Observe corporate formalities (even when it seems silly to do so). A good business, even one with a sole shareholder, keeps corporate meetings, elects board members (even if there is only one) and keeps minutes. Closely held businesses and sole-shareholder corporations may find this a waste of time -- but dotting the i's and crossing the t's keeps shareholders safe and makes for responsible businesses that can keep up with their debts and meet legal liabilities.

As always, if you are a small business in the Pittsburgh area in need of legal advice, call my office for a free consultation. (412) 246-2023.

Peter H. Kurzweg, Esq.