Impact of Losses to Business

April 13, 2006

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If an uninsured loss hits a business itself (such as the accidental destruction of the business's computer system, or a lawsuit based on a "slip-and-fall" that happened on the business premises), the business's owner could be affected in two ways.

First, the loss may cut business profits, or make it necessary for the owner to pour more money into the business to keep it afloat.

Second, the owner may have legal liability to others to pay for the business's loss. The extent to which a business owner can be held financially responsible for debts and legal judgments of his or her business depends on several things, including the legal form in which the business owner owns and operates the business.

Generally speaking, if you run a business as a sole proprietorship or partnership, you will be personally liable for any debts or legal judgments that your business owes. The amount that you can be required to pay is not limited to the income you make from the business, or its value.

John Hyde operates his own business that formulates and distributes skin care products. The business, which is not incorporated, generates a yearly income of $30,000 and is worth about $90,000. Due to an error in mixing the components of one of his products, 10 customers sustained severe skin burns. Assuming that the customers' claims will total $150,000, Mr. Hyde will be liable for the full $150,000.

If you run the business as a corporation (including a corporation that is classified as an S corporation for purposes of your federal income tax return) or as a limited liability company, you will generally have what the law calls "limited liability." In theory, this means that your legal liability for the debts of your business normally will be limited to the amount of your investment in the company. In other words, you might lose your business, but you won't lose non-business assets such as your house or your car.

However, there are exceptions to this limited liability rule. Your may lose your limited liability as a corporation if:

You fail to respect the corporate structure by actions such as treating corporate property or money as your own personal property.
Your corporation is undercapitalized. That is, the corporation does not have anything near the amount of assets that it may need to meet liabilities.
You voluntarily waive limited liability (such as by agreeing to guarantee, as an individual, the debts of your corporation).

And when a significant amount of money is at stake in a lawsuit, attorneys will work hard to exploit those exceptions so that they can collect legal judgments against you personally.