It is true that the owners or shareholders of a Corporation, LLC, or Limited Liability Partnership are not liable for debts of the business entity just because they own the entity.
This legal concept is called limited liability, and it is one of the most important parts of modern business law.
Banks, however, almost always insist on getting a personal guarantee from the owners whenever they loan money to a business.
WHAT IS LIMITED LIABILITY?
Limited liability is a legal doctrine that protects owners of a business from the liabilities of that business.
Liabilities are money that the business must pay out, and include debts and any damages for illegal acts of the company.
If the owners of the business have limited liability, then the most money that they can lose on the business is the amount of money they invested in the business.
Limited liability is the reason that:
- Shareholders of BP were never asked to pay for the damages caused by BP’s oil spill
- Shareholders of American Airlines did not have to pay creditors when American Airlines filed for bankruptcy
Shares of these companies lost value, and investors lost money because their shares lost value, but the shareholders themselves had no fear of being sued.
WHAT IS A PERSONAL GUARANTEE?
A personal guarantee is a contract that makes one person or entity owe the debts of another – such as a cosigned loan.
How does this work?
If you cosign someone’s car loan, then you have to pay that loan if the other person doesn’t.
Because banks know that corporations and LLCs have limited liability, they will usually lend money to a corporation or LLC only if the owner or someone else signs a personal guarantee.
The personal guarantee gets rid of limited liability for the bank debt, because it allows the bank to collect from the owner/guarantor if the corporation or LLC fails.
Even if the bank did not specifically tell you about a personal guarantee, they probably got you to sign one when you took out your business credit.
This is standard business practice, and so far as I can tell, it is required of any business that has an identifiable owner. The SBA also insists on personal guarantees.
Who uses personal guarantees?
Merchants, suppliers, and service providers also commonly have personal guarantees in their form contracts.
If you run a business, you have probably signed many of them without being specifically aware of it.
The government also makes business owners, and occasionally their CFOs or accountants personally liable for certain tax debts.
The bank’s personal guarantee only covers the debts to the bank, so an incorporated business owner would still have limited liability in the event that one of his employees ran over someone with a car, or somehow caused an actionable injury.
If you’re the owner of shareholder of a corporation or LLC, then you’re likely to be liable for some debts, despite limited liability.
If you’re thinking ofr filing for Chapter 7 Bankruptcy or Chapter 13 Bankruptcy, then speak speak to us first so we can advise you.
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