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A common slip-up can undo the benefits of setting up a separate business entity, such as a corporation, a limited partnership, or a limited liability company. Failing to notify your customers, your creditors, and everyone you deal with of the legal structure of your business can cost you a lot.
First, understand who is liable for a business debt. If you are the “owner” (proprietor) of a business, but it is not a separate legal entity, then you are liable for all of the debts and other obligations of the business. Consider John’s Clothiers on Main Street. The owner, John Jones, is liable if John’s Clothiers fails to pay its supplier for its suits; he may also be liable if an employee hits a pedestrian while delivering alterations to a customer. The reason is that John’s Clothiers is not a separate legal entity.
Partnerships carry the same liability as proprietorships, but in some ways they create worse exposure for business obligations. Not only is a partner liable for his own acts and perhaps the acts of the business’s employees, but the partner is also liable for the acts of the other partner. So, if John Jones take a partner in Jane Smith, and Smith orders 100 Blue Devil ties which never sell, then both Smith and Jones, the partners, are liable for the debt. It doesn’t matter that Jones didn’t approve of the purchase; nor does it matter if he didn’t know about it.
Corporations, limited partnerships, and limited liability companies are examples of entities that limit a person’s liability for business debts. If Jones incorporates John’s Clothiers, the newly formed corporation will be liable for its debts; but Jones, individually, will not have any liability, unless he signs a personal guarantee. The same is true for limited partnerships and limited liability companies.
But, what happens if the business IS incorporated, but only John Jones and his accountant know? The answer might surprise you.
A person who contracts as if he is a proprietor, when he is in fact an agent of a legal entity, can be held liable for that entity’s debt as if a separate entity did not exist. The legal theory, known as an “undisclosed principal,” holds the agent responsible, and allows the creditor to sue the agent individually for the debts of the business.
What can you do? There are several simple steps you can take to make clear the existence of your business entity:
John’s Clothing Ventures, Inc. t/a (trading as) John’s Clothiers by John Jones, President
Bettie Kelley Sousa has been practicing law with Smith Debnam since becoming licensed in 1981. She is a Board Certified Creditors’ Rights Specialist. She has a wealth of experience in state and federal courts, including bankruptcy courts, at both trial and appellate levels. She represents mostly businesses — both large and small — in a variety of matters, including contract drafting and disputes, and issues pertaining to employment laws in North Carolina....LEARN MORE