Understanding Limitations on Corporate Liability
Corporations confer a variety of benefits on their shareholders and executives. One of the most important benefits from a business litigation standpoint is that the corporate structure creates a way for investors to limit their liability in the company in case something goes awry. This limited liability means that in most circumstances, the corporation’s investors cannot be held personally responsible for the acts of the business, but instead the business itself is responsible for paying its debts. However, there is an exception to this rule in certain cases where courts choose to “pierce the corporate veil.” When that happens, people can have their own personal assets taken in order to compensate people to whom the business owes money.
The General Rule of Corporate Liability
One important idea sits at the core of corporate limited liability; corporations are legal entities that are distinct from the people who own or operate it. This means that when the corporation takes on a debt or is held responsible for an injury by a court, it is responsible for paying off that debt on its own, rather than relying on the personal assets of the investors. This is not just true of limited liability corporations. It also applies to other corporations, such as S corporations and C corporations. However, it does not apply to sole proprietorships or partnerships.
Of course in a practical sense, this distinction can be a bit abstract. After all, a corporation has to act through its agents and it receives money to pay these debts from investors along with customers. Yet, an example can help show how important this limited liability can be.
If a person is a 100 percent owner in a corporation, then they may have invested $100,000 in it. Assuming the company is successful, that $100,000 may eventually grow until the company is worth $200,000. Suppose now that the company is sued and owes $300,000 in damages. Assuming the judge chooses not to pierce the corporate veil, then the company can pay the $200,000 towards the damages, but the owner of the company has no obligation to pay the final $100,000 out of their own pocket.
Piercing the Corporate Veil
Importantly, there are situations where courts may choose to hold the owners of the company personally responsible, but this usually happens in cases where there is some sort of wrongdoing or failure on behalf of the corporation’s owners. One common reason for courts to pierce the corporate veil is if the company’s owners fail to properly respect corporate formalities, such as holding regular board meetings, to the point where there is no real separation between the company and the owner or owners. Another potential reason for a court to pierce the corporate veil is in instances of undercapitalization. Undercapitalization occurs in instances where a company’s owners have failed to give it enough assets to adequately answer for its debts, often with the goal of exploiting the rule of limited corporate liability.
Limitations on corporate liability are just one unique feature of lawsuits involving corporations. If your company is currently involved in such a lawsuit, contact a Florida business litigation attorney at Pike & Lustig, LLP today.