Well, let’s start at the beginning. Corporations and LLC’s are designed to protect the personal assets of the owners of that entity under the concept of “limited liability” – i.e. that any legal liability that may arise within the business, attaches only to the business assets. So, say there is a successful lawsuit against the business, only the assets of the business can be used to pay the lawsuit. The personal assets of those individuals who have invested in the company are safe so long as they acted in good faith on behalf of the business entity. However, take a situation, for example, where a drunken limo driver injures someone, both the limousine company and the driver are going to be sued. How could he not be personally liable when he’s drunk and driving? Now if the “driver” is also the owner of the company, yes he is going to be sued for his personal wrongful acts, even if the limo company is a corporation or LLC. The long and the short of it is that gross negligence, fraud, theft and other unlawful behavior is never protected. Otherwise, forming a corporation or LLC would literally be a license to steal.
Now, if the limo driver was completely sober, didn’t break any laws and had a client, on their own, decide to exit the car while it was still moving and such client was subsequently injured, would there be personal liability on the driver? Probably not. In that case only the corporation or LLC assets could be attached if a judge or jury found in favor of the limo client.
Beyond the obvious scenario above, you might still ask why bother? Here are several more reasons:
1. Limited liability will protect against creditors (where you the owner have not guaranteed the debt personally or signed personally) if the business goes under;
2. The court may decide that, even in a lawsuit for injury, the conduct was purely “business” conduct and not the conduct of you the owner, as an individual, and therefor worthy of limited liability protection;
3. There are certain tax advantages allocated to corporations and LLCs, especially Sub S corporations. You may actually save money by establishing a legal entity and allow your CPA to take advantage of the tax code and,
4. In truly negative legal situations, it gives your defense council a negotiating position. If the business is just you, or you doing business as (dba) another entity, then everything you have is at risk. EVERYTHING. Your house, your bank accounts, your investments, your personal property, etc.
But if you are a corporation or LLC, then your lawyer can argue, negotiate and settle the case based upon the position that the other side may lose if it tries to go after you personally. If you are not a corporation or LLC, you take away a very important negotiating tool and legal argument from your lawyer, and yourself, if things go wrong.
One final thought. Having said all of that about why you should create an independent legal entity from yourself, never forget that in business the liability protection of a corporate type entity is a line of defense, but not the best. It is what you turn to when all else has not worked. Your first line of defense is insurance for your business, officers and directors.