Guest post by Elena Volkova, Esq., Roizin & Volkova Law Group PLLC
My answer is: No, it is not true. But the devil is in the details. First of all, let’s define what we mean by “protection.” When people form a corporate entity, they do it primarily to protect their personal assets (like their savings and personal property) against business debts and liabilities.
This protection is called “limited liability.” It is not absolute, meaning, in some circumstances, an owner of the business entity may be personally responsible for the acts of the business entity. These circumstances include unpaid wages, patent and copyright infringements, acts of fraud and insufficient capitalization of the company. This is why any business entity also needs a general liability insurance to protect itself against unforeseen expenses.
Aside from these fairly limited circumstances, the business entity is responsible for all of its obligations, and the owners will not be required to dip into personal assets to pay for those obligations.
This is what we mean when we talk about “protection by incorporation.” Both a limited liability company (LLC) and a regular business corporation allow limited liability to the owners.
What are the differences in the protection you get?
In order to take advantage of the protections, the business owners must follow certain rules, called corporate formalities. This is where the difference between an LLC and a regular business corporation emerges.
The Rules of Business Corporations
For example, the statute governing business corporations in New York requires…
- The owners (called shareholders) to elect the board of directors and to approve all major corporate actions in a meeting or in writing.
- All major decisions of shareholders must be written down in resolutions, and the resolutions must be kept in the corporate book.
- The evidence of ownership (a share certificate) must be issued and documented in the corporate book.
There are a few other formalities, but the lack of following any of the rules may create confusion and expose the owners to personal liability.
The rationale is that, where owners do not treat the corporation as a separate entity with its own set of rules, they cannot expect to take advantage of the corporate protection that these rules offer.
The Rules of Limited Liability Companies
As an example, the statute governing limited liability companies in New York requires…
- Its owners (called members) to adopt the operating agreement which serves as evidence of ownership. (The operating agreement also sets out the rules of how the company is run.)
- There is no requirement to hold regular meetings, write resolutions, or elect the board of directors.
- The only caveat – if not all members are involved in managing the business, the articles of organization must state that the LLC is being managed by a manager, not members.
Because there are so few formalities for an LLC, the lack of corporate resolutions or certificates evidencing ownership will not be considered a violation of the statute (if the operating agreement so allows), and cannot be used as a factor to hold an owner liable for the acts of the company.
So which one gives owners more protection?
Because there are fewer corporate formalities required to maintain an LLC, the owners are less likely to be personally liable for the LLC’s actions with all other factors being equal.
The “Other Factors”
These other factors are a major qualification to my answer. They’re different for every business, and they can only be explored and discussed with actual facts and circumstances in mind. The best way to explore and discuss those factors? With the assistance of an experienced business attorney.
If you have any confusion or concerns about whether your business entity gives you sufficient protection against liability, please check with an attorney in your state. If you live in New York, I invite you to schedule a consultation so we can resolve this issue based on your particular situation.
This article does not constitute legal advice or create an attorney-client relationship. This is a general statement of principles of New York corporate law. Please consult an attorney to determine how this applies to your situation.