Case Study: Properly Signing Contracts

April 13, 2006

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In order to avoid the contract exceptions to limited liability, a small business owner needs to take care in the way contracts are executed.

As a rule, do not sign any contracts until after your business entity is formed, because pre-formation contracts hold the owner personally liable for the contract.

Then, be sure the principals to the contract are clearly identified, and the owners are signing as agents of the principals (the businesses), disclosing their representational capacity. This ensures only the principals are liable on the contract.

Let's say John Smith is the owner of ABC, LLC, and wants to sign a contract with a supplier, XYZ Supplies, Inc. Smith should execute the contract as follows:

Parties to the contract:

Seller: XYZ Supply, Inc

Buyer: ABC, LLC

* * *

Signed: ABC, LLC

By: John Smith, Manager

John Smith, Manager

(Of course, the contract would also be signed, similarly, by an agent of XYZ Supplies, Inc.)

Because the name of the entity, ABC, LLC, appears at the top of the contract, it would be acceptable to omit repeating the name of the principal a second time above John's signature, as follows:

Signed: By: John Smith, Manager

John Smith, Manager

Note that it is customary to print a name under a signature (if the name is not printed elsewhere in the contract) so that the party's name can be clearly identified.

Now let's assume that XYZ Supplies, Inc. insists on a personal guarantee in the contract from John Smith, the owner of ABC, LLC. The contract will look like this:

Parties to the contract:

Seller: XYZ Supply, Inc

Buyer: ABC, LLC

* * *

Signed: ABC, LLC

By: John Smith, Manager

John Smith, Manager

Signed: John Smith

John Smith

The second signature makes Smith personally liable on the contract.

Usually, language regarding the personal guarantee will appear before the second signature. This language may make the owner primarily liable, along with his entity, so that the creditor can call on either immediately to pay the debt:

"The undersigned hereby personally agrees to perform all of the obligations in this contract."

Or, the language may make the owner a surety, or guarantor, who agrees to pay the debt only if it is not first paid by the entity:

"The undersigned hereby personally agrees to perform all of the obligations in this contract in the event ABC, LLC does not perform these obligations."

With a one-owner business, the two alternatives will probably produce no difference in outcome. However, with a multiple-owner business, the individual owner usually will prefer to act as a surety, rather than a co-primary party.