Do Corporations or LLCs Always Protect You?

llc-asset-protectionAs an experienced forensic CPA and fraud examiner, there is very little I have not seen. Often, there may be several versions of the accounting records: one for the business owner; one for the owner’s partners; one for the IRS and one for the spouse. Although I am being somewhat facetious, the reality of business records which stretch credibility whether by design, fraud, diverting of funds or for personal reasons can result in serious consequences.

Companies are sued for many reasons these days: discrimination, sexual harassment, fraudulent financial statements, failure to pay creditors, and more. Businesses incorporate for personal liability protection, among other considerations. A corporation or limited liability company creates a legal protection between the business owner and the acts of the entity if properly respected. That protection can include personal liability against the type of lawsuits previously mentioned. Otherwise the risk of conducting your business can run beyond the level of prudent risk to which you can afford or wish to be exposed. However, this protection is not an automatic entitlement. For instance, failure to pay governmental trust funds such as income taxes withheld from employees and sales taxes withheld from customers will become a personal liability.

In addition there are many rules, regulations and requirements that owners must follow in operating their business. Violating these rules, regulations and requirements can actually void the liability protection against lawsuits and other liabilities. This illustrates the importance of responsible and diligent management of a corporation.

If a special purpose entity (a related corporation commonly owned) is used as a vehicle to commit a fraud, avoid obeying the law or perpetuating a wrongful purpose, the liability protection may be voided by the courts. Smatterings of these acts I have observed over the years through personal forensic analysis consist of:

  • Corporate debt knowingly incurred while the company is insolvent
  • Conducting the business as a sham to cover up some other activity
  • Failure to hold annual shareholder/board meetings or issue minutes in lieu of a meeting
  • Business formalities and recordkeeping are either ignored or treated with no respect.
  • Officer loans are not properly documented
  • Commingling of funds with the owners

Business owners may be putting themselves at personal risk by not operating their business responsibly and thereby jeopardizing the legal protection afforded by corporations and LLCs under normal conditions.

Dennis B. Kremer, CPA/ABV/CFF/CGMA/CVA