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None of Your Business? NOT HARDLY!

June 01, 2004 Bettie Kelley Sousa

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:

  • All of your letterhead needs to contain the exact name of the business entity. If your company has a trade name, it’s fine for the trade name to be predominant on the letterhead; but somewhere, possibly across the bottom of the stationery, the exact business entity name should appear. For example, the top of the letterhead could boldly show “JOHN’S CLOTHIERS,” but located some where on the letterhead should be an explanation “A tradename of John’s Clothing Ventures, Inc.”
  • If your corporate or business entity name is different from the company’s trade name, then a notice should be filed with the Register of Deeds in the county where the company trades which demonstrates the existence of the two names. The notice, entitled an Assumed Name Certificate, is a simple form that states the trade name and the true business entity name. This notice serves to put third parties on notice through the public record that the entity goes by both names
  • All contracts signed for the business entity should CLEARLY reflect that the signing person is signing in a representative capacity. John Jones should sign his contracts:
  • John’s Clothing Ventures, Inc.
    by John Jones, Presidentor

    John’s Clothing Ventures, Inc.
    t/a (trading as) John’s Clothiers
    by John Jones, President

  • All company checks should clearly be in the name of the business entity. The bottom signature line should have the business entity’s name ABOVE the signature line, so that the person signing for the entity can note that he or she is signing for the business. If the person signing is a bookkeeper, and not an officer, then the designation “agent” is fine
  • Make sure your business entity keeps a separate bank account, files tax returns, maintains its corporate status by filing annual reports with the Secretary of State, and keeps its obligations in its name. A good example is to make sure that any company owned vehicles are in the name of the business entity, and that the contract for insurance is in the name of the business entity
  • If any loans are made from you to the business entity, make sure that they are well-documented with promissory notes and agreements providing for retention of security interests in collateral
  • In short, don’t expect a creditor to treat a business entity separate from you if YOU don’t treat it that way. If your business is set up in a separate legal entity and you are dealing with customers or creditors, MAKE IT their business to know your business!
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