Limited liability is one of the main benefits of forming a business entity, such as a corporation, limited liability company or limited partnership. It means that the owners of the entity are not personally liable for the debts and obligations of the business, unless they agree to be so. However, there are ways to lose this protection and expose personal assets to creditors.
One way that a business owner can lose their limited liability is by tax forfeiture. This occurs when an entity fails to file its annual franchise tax report or pay its franchise tax to the Texas Comptroller of Public Accounts. The Comptroller may then forfeit the entity’s right to do business in Texas and notify the Secretary of State. The Secretary of State may then terminate the entity’s existence and revoke its charter or certificate. When an entity is forfeited or terminated for tax reasons, its owners may be personally liable for any taxes due, and any debts incurred by the entity after forfeiture.
Piercing the corporate veil
However, one of the most common ways that a business owner can lose their limited liability is through a lawsuit that succeeds in piercing the corporate veil. This is a legal doctrine that allows a court to disregard the separate existence of the entity and hold the owners personally liable. Courts consider various factors when deciding whether to pierce the corporate veil.
The courts look at the capitalization level and whether it was adequate for the business the entity engaged. Judges also look at whether the business owners followed corporate formalities, such as holding meetings, keeping records and filing reports.
Courts also look at whether the entity and the owner were kept separate. This includes whether the entity had separate bank accounts and financial statements and whether there was commingled personal and business funds or assets. Judges also look at whether the entity was actually an alter ego or instrumentality of the owners and whether they siphoned funds or paid themselves excessive salaries or dividends.
Another way that a business owner can lose their limited liability is by giving it up by signing a personal guarantee. By signing a personal guarantee, the business owner waives their limited liability and exposes their personal assets to the creditor in case of default. Personal guarantees are often required for various business processes, especially for new entities.
Limited liability is a valuable asset, but it is not invincible. Business owners can destroy their own limited liability status in a Texas limited liability entity if they are not careful. The attorneys at Deans Stepp Law are experienced at battling these issues and will fight for you.