Wadbottom’s Exposure – Are You Protected?
Years ago, in an earlier newsletter, we talked about Lord Wadbottom and how, in the early days of British law, corporations were formed to protect the personal wealth of shareholders and investors from liabilities from business activities.
A quick example — Just because you own stock in General Motors does not mean your home will be seized to pay the creditors of General Motors, should General Motors be sued and lose.
Let=s fast forward several hundred years to the current era and look at the limited liability afforded by today=s corporations and Limited Liability Companies (“LLCs”).
In more recent times, say approximately the past 15 years, the concept of Limited Liability Companies has been developed, and there are numerous newsletters on this Website concerning how LLCs operate and the protection they afford.
Lord Wadbottom=s descendant, Wadbott (they shortened the name), “Wad” hereafter, is starting his own business. Can Wad obtain limited liability simply by forming a corporation or LLC? Yes, but depending upon the circumstances, the protection may not be total or complete as it relates to Wad.
A common misconception among a wide range of individuals (some of whom have formed businesses) is that by incorporating or forming an LLC, either entity will provide unlimited liability protection no matter what the principal has done. This notion is seriously in error.
Let=s assume that Wad owns a small delivery service and has one employee, Del. All of the deliveries are made by Wad and Del. If Wad incorporates or forms an LLC called TuFast, LLC, will there be limited liability protection for the driving accidents caused by Wad?
Unfortunately for Wad, the answer is “no.” The reason the answer is “no” is that the person performing the act, whatever it may be, is liable for his or her own mistakes without regard to the entity for whom it is done. Personal actions create personal liability.
For example, if the president of General Motors is driving a GM car to work and causes an accident, GM will be sued, as will the driver of the car, the president. Will the president have limited liability for his faulty driving? No. The message is that forming a corporation or LLC does not protect the principals from their own acts.
Stated differently, personal liability for the acts of a principal cannot be avoided by the formation of an entity providing limited liability. Quite importantly though, Wad would be protected from personal liability for the independent acts of Del, because of the limited liability afforded by TuFast, LLC.
Using another example, let=s say that Del causes an accident. Because TuFast, LLC, hired Del, TuFast would be sued because its employee, Del, caused the accident. Del, of course, is personally liable since he was driving the delivery vehicle. Can a creditor get to the personal assets of Wad because of Del=s accident? Probably not, assuming Wad was using reasonable diligence in hiring and supervising Del and did not have reason to know that Del had been arrested 35 times previously for drunk driving.
Expressed in a different manner, assuming Wad exercised reasonable business discretion in hiring and directing Del, it is unlikely that the personal assets of Wad could be subject to liability because of the claim against TuFast, LLC, created by Del’s acts.
The message is that if you have employees who are using vehicles or working with other subcontractors, limited liability can be important whether it is obtained through a corporation or an LLC. People should not, however, form LLCs or corporations on the blind faith that by forming the entity they will protect themselves from all creditors.
Limited liability can, in theory, be obtained with regard to contractual liabilities. Let’s say the supplier of a vehicle agrees to look only to the entity, TuFast, LLC, for payment. With most small businesses, this is extremely unlikely, because the owner will be asked to guarantee the debt so if the business is unable to pay, then the principal will ultimately have to pay the debt.
If you have questions about the concepts of limited liability, call Newland & Associates.
Copyright 2003
Published by the law firm of Newland & Associates, PLC
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