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4. INITIAL OPERATIONS

d. Risk Management

Personal Liability

The owners of corporations, LLC's, and limited partnerships are usually not personally liable for the debts and obligations of their companies. Instead, the owners are responsible only for making initial capital contributions in exchange for ownership interests. The only exception regards the general partners of limited partnerships, who are fully liable for the debts and obligations of their companies.

Directors, officers, managers, and employees are agents of their companies. Applicable law usually protects agents from personal liability for the debts and obligations of the companies they serve. In addition, companies usually agree to indemnify agents from any business-related claims of third parties.

However, the liability protections of corporations, LLC's, and limited partnerships are not airtight. Business owners and agents may incur personal liability under some circumstances, such as the following:

1.They commit a crime, “tort”, or statutory violation. (A "tort" is a breach of a duty imposed by law. One example is the tort of negligence.)

2.They breach a fiduciary duty owed to an owner. (Individuals who control or manage a company usually have fiduciary duties. These duties are due care, loyalty, and perhaps "good faith and fair dealing", and candor.)

3.The company causes personal injury or property damage, and (i) the company and its insurance carrier fail to compensate the victim adequately; and (ii) the owners treated the company as an “alter ego” instead of a separate and distinct legal entity.

Minimizing Risk

To minimize the risk of personal liability, do the following at all times:

• do not commit any crimes, torts, or statutory violations in connection with your company
• if you control or manage your company, do not breach your fiduciary duties
• do not refer to the owners or managers as “partners”
• execute written governing documents drafted by a competent business attorney
• act in accordance with the governing documents
• amend the documents from time to time to reflect changed circumstances
• capitalize your company sufficiently to meet foreseeable expenses
• make additional contributions, loans, or gifts to the company to meet start-up expenses
• open bank accounts for the company and obtain company credit cards
• pay company expenses only with company funds
• do not commingle company funds with the funds of any other person
• maintain separate operations and financial records from all other persons
• identify the company as a corporation, LLC, or LP in all marketing materials and legal documents
• hold formal meetings as required by law or your governing documents
• take minutes at any formal meetings
• execute written votes, resolutions, or consents
• keep clear records of major business activities
• for transactions with a conflict of interest, (i) have the company represented by someone other than the conflicted owner or manager; (ii) execute a formal written agreement between the parties; and (iii) disclose the transaction to the other owners or managers and get their approval in writing
• execute all business letters, agreements, checks, or other documents in the name of the company and only by authorized personnel
• withhold and pay payroll taxes in connection with any employees
• do not make distributions that result in the insolvency of the company
• obtain adequate insurance coverage for the company

Insurance

With regard to the last bullet point, you should meet with an insurance broker and discuss appropriate coverage for your company. In general, business insurance may be divided into two types: “property” and “liability”. Property insurance protects the company from damage to its own property. Liability insurance protects the company and possibly its individual owners and managers from damages caused to third parties.

Insurance is usually optional. However, applicable law may require insurance in some cases. For example, California requires all employers to carry workers' compensation insurance. In addition, state and federal law may require companies in certain industries to maintain liability insurance. Examples are the banking, public transportation, and architecture industries.

Ask your insurance broker about the following types of policies:

• property
• commercial general liability (CGL)
• advertising injury
• workers’ compensation
• automobile
• directors and officers (D&O)
• errors and omissions (E&O)
• business interruption
• life and disability insurance for key personnel

Life and disability policies are especially appropriate for companies that execute “buy-sell agreements” with their owners. A buy-sell agreement requires a company to buy back the stock or membership interests of an owner upon his death or disability. The insurance provides the company, as the named beneficiary of the policy, with the cash to repurchase the ownership interests.