WHEN CAN YOU FACE PERSONAL LIABILITY FOR BUSINESS DEBT?

Personal liability for business debt

You Can Become Liable for Corporate Debt if You’re Not Careful

Avoiding personal liability for business debt is why most business owners form a corporation or limited liability company (LLC).  With a corporation or LLC, an individual and their business are separate legal entities. An owner has no personal liability for debts that their business incurs.

However, even if you do form a corporation or LLC by filing the proper papers with the Secretary of State to start your corporation or LLC, there are various ways an owner can negate the premise that the corporation is a separate entity and face personal liability for business debts.

Most banks, finance companies, and landlords know that LLC members don’t have personal liability for their company’s debts, so they often won’t extend credit or lend money to small LLCs without a personal guarantee from the owner (i.e., the owner promises to pay back the loan personally if the business doesn’t.)

If an LLC business owner puts up their house or other real estate as collateral for a business loan, then they’re personally liable for the debt. If the business defaults, the creditor can sue the owner to foreclose on the property and use the proceeds to pay off the debt.

Simple carelessness may sometimes have an owner assume personal liability.  For instance, if you inadvertently sign an agreement with your personal name rather than your company’s name, you’re now personally liable for any debt—even if it was a supplier’s mistake.   Sometimes, in fact, it is not a mistake and the contract prepared by the supplier is designed in such a way that when the owner completes his or her name and signs, the owner is signing both for the company and on his own behalf, thus facing personal liability.

Using a personal credit card or home equity loan to supply funding to your business automatically makes you face personal liability for those debts.   However, you can also create personal liability when you use business credit cards to pay for personal debts because a creditor can then argue that your corporation was a sham and was just your “alter ego.”   If they can show that the corporation was just your “alter ego,” this is also called “lifting” or “piercing” the corporate veil.  This, again, means that the creditor can go after your personal assets for the business debts.

You also can expose yourself to personal liability if you don’t follow such corporate formalities as having regular board meetings or minutes.  In some cases, for some federal wage violations, an owner of a corporation can be personally liable if the corporation does not follow federal wage laws.   Finally, if you’re caught lying or misrepresenting the facts when applying for any business loan for your corporation or LLC, you’ll likely be personally responsible for the debt.

Filing with the secretary of state to start your corporation or LLC and to create a separate legal entity is a good and essential step to protecting your personal assets from your business liabilities.   However, it is only a start and it is not a guarantee.   As you can see, you still need to be careful to preserve that legal protection, to follow legal formalities and to protect yourself from personal liability for your business debts.   When in doubt, seek help or advice.

SMALL CLAIMS COURT: CAN IT HELP YOU GET PAID?

Small Claims Court May Be an Effective Way to Get Paid
Small claims court may help you get paid

Small Claims Court May Be an Option

Small claims court can sometimes be an effective way to get paid for debts less than $5,000 for a corporation or $10,000 for an individual.   Here’s what you need to know about small claims court in California.

HOW IT WORKS:

In California small claims court, there are no lawyers, juries or rules of evidence in California.   You pay between $30-$100 to file it.    After you file and start your small claims court case, the court will set the date for the hearing.   You then must serve notice of the hearing and a copy of your complaint on the person who owes you money (the defendant).    He or she can respond and even seek money they think you owe him or her.

On the day of the hearing, you – not a lawyer — appear before the small claims court judge and present evidence about why the defendant owes you money.  Defendant has an opportunity to respond or say why you owe  them money.   Normally, the small claims court judge does not give you an answer at the hearing but mails out their decision as to who wins.

If the plaintiff loses, they cannot appeal the decision.  If the defendant loses, they can appeal.   Even if the plaintiff wins, they normally must wait 30 days before trying to collect on the judgment.

POTENTIAL PITFALLS OF SMALL CLAIMS COURT:

There are unfortunately, several potential pitfalls to Small Claims Court:

INADEQUATE SERVICE.    Proper service is required for the small claims court to be able to give you a judgment or to have any control over defendant.  If you get it wrong, the court can refuse to hear your case or give the defendant a grown to attack the judgment.

INADEQUATE PREPARATION.   Even in small claims court, you need evidence to prove your case.   This is one occasion where you need to practice and prepare and, if necessary, get help.

COUNTERCLAIM.    A counterclaim is when the defendant claims you owe them money.     If you know that the defendant has a counterclaim, you should consider whether it even makes sense to pursue your claim in small claims court against them.

COLLECTIONS.   Even if you win your case against the defendant, you will have to collect that judgment.    If the defendant does not have assets, it’s problem not worth suing them in small claims court.

Although an attorney cannot appear for you in small claims court, to avoid these pitfalls, it may make sense to consult with an attorney either to help avoid these potential pitfalls.  Despite, the potential pitfalls and limits to small claims court, in many cases, this is an effective way to collect on your debts.