LLC and Corporations: Are You Protected?
By Jason Rebraca
Johnson & Johnson Law Firm
YOUNGSTOWN, Ohio – In my nascent career in litigation, I have come across an alarming number of corporate litigants who – through their own conduct – have compromised the liability shield typically afforded to such entities. These self-inflicted wounds can mean the difference between limited liability and personal liability.
Below I will review a few reasons why a business owner might still face personal liability even after endeavoring to create and operate a limited liability entity.
Most frequently, the person who forms the LLC or corporation does not actually operate (or hold himself/herself out) as the LLC or corporate entity. For example, the business owner affirmatively incorporates “A-1 Services LLC,” but operates as and holds itself out as “A-1 Services.”
Businesses that have created a limited liability entity but do not make plain to their customers that the limited liability shield exists may be susceptible to personal liability.
The fix here is easy: contracts, letterheads, business cards and even signage should clearly identify the limited liability protection associated with such entity by explicitly including “Inc.,” “LLC,” or “Corp.” as appropriate.
Additionally, some business owners mistakenly believe they are entitled to limited liability protection through their use of a fictitious name. Though a person can contract, sue, be sued, and hold title to property under a properly registered fictitious name, the fictitious name does not afford a liability shield, which makes the registrant still subject to personal liability.
The person using a fictitious name when entering into a contract is the actual party to the contract. Likewise, a deed to a fictitious name is really a deed to the person operating under the fictitious name.
Or a business owner might incorporate an LLC and not flush out the ownership structure with an operating agreement. Although the business may be closely held by a small number of owners, or even by a single person, the “legal fiction” of the limited liability entity should nevertheless be perpetuated by these types of management documents.
Lacking these types of documents allows a litigant to plausibly allege that the limited liability entity is a sham, or has not been dutifully operated as such, and therefore the individual members should face personal liability.
Although courts are generally reluctant to impose personal liability where limited liability is facially attempted, the well-papered corporate litigant likely appears more legitimate in the eyes of a jury than the litigant whose annual minutes were written on a bar napkin.
The overarching legal principle here is called “piercing the corporate veil.”
The courts use this term when shareholders of a corporation are held personally liable for the debts of the corporation. In certain circumstances – like those described above — the corporate form is disregarded, or pierced, for the express purpose of reaching the assets of the corporation’s individual shareholders.
When a person misuses the corporate form as a shield from liability for his/her own misdeeds, Ohio law will permit piercing of the corporate veil as a rare exception to the guiding principles of limited shareholder liability.
Ohio looks to three specific factors to determine whether a claim may pass through to a member or shareholder.
A plaintiff must establish three things.
First, the party must exert control over the corporation in a manner so complete that the corporation has no separate mind, will, or existence of its own. Second, those to be held liable must commit fraud or an illegal act or a similarly unlawful act against the person seeking to disregard the corporate entity. Finally, injury or unjust loss must result from the control.
So please mind the paperwork. And be wary of online services that offer quick, easy and cheap corporate or LLC registrations.
I recently reviewed documents for a client who used such a service that guided him into the creation of a limited partnership. Unfortunately for him, the limited partnership structure was wholly inappropriate for his intended business use. A limited liability company made a lot more sense.
Business owners take enormous pride in their work. Be sure to start from good foundations and respect the benefits of your chosen entity.
Copyright 2023 The Business Journal, Youngstown, Ohio.