In this age of information, most small business owners understand they need the protection provided by a corporation or limited liability company. Such protection, however, can be lost though certain actions.

Criminal Action

Creating a business entity only protects a business and shareholders from civil liability. Civil liability arises from a body of state and federal law that allows for compensation for alleged wrongs. These wrongs can arise in the form of negligence, contractual breach and so on. If an entity is found civilly liable, it must pay compensation, but no jail time is involved.

Neither a corporation, limited liability company nor any other entity will protect anyone from criminal liability. Claims to the contrary published on various web sites are simply wrong. A person forming a corporation to front for a ponzi scheme or scam to defraud consumers is going to receive no protection from criminal prosecution. If you have any doubts on this issue, simply consider the recent criminal convictions of the Tyco and Enron executives.

Standing Apart

Both corporations and limited liability companies are considered to “stand apart” from their investors for legal purposes. In essence, both entities are considered to be “persons” under the law. This legal fiction is, of course, what gives rise to the asset protection element of both entities. Unfortunately, many small businesses don’t understand this distinction and lose the asset protection when the most need it.

To maintain the asset protection benefits of a business entity, you must treat it as an independent party. For instance, you do not “own” a corporation. Such statements can come back to haunt you when a plaintiff’s attorney presents them in court while arguing the entity is a sham. To avoid this problem, you can simply say you are the President of the business entity or whatever position you hold.

In Closing

Forming a business entity is a necessary step for most small businesses. Once the entity is formed, make sure you follow the necessary formal procedures to maintain asset protection.