Limiting Liability for Contracts and Torts

To avoid day-to-day liability risks when running a small business, the mere formation of a limited liability company (LLC) or a corporation is not a sufficient asset protection strategy. As discussed in our section titled, "Limit Liability in Your Business Structure," the entity must be structured and funded properly to limit exposure to liability.

Moreover, even properly structuring and funding the LLC or corporation is not sufficient, because some assets remain vulnerable within the business entity itself. The LLC or corporation must be operated properly, in ways that preserve limited liability granted by law.

Specifically, significant exceptions to limited liability exist, in terms of both contract and tort liability. When an exception applies, limited liability is lost, and the owners of the business have unlimited, personal liability for the business's debts. Yet, most times, with proper planning, these exceptions successfully can be avoided. The first step is understanding the nature of contract law.

Warning The unfortunate truth is that most small business owners operate their business blissfully unaware that they have a tremendous exposure to liability through contracts or torts (acts or actions whose outcome produces a lawsuit or settlement forcing payment of monetary damages). Perhaps they are under the illusion that the LLC or corporation they formed will protect them from liability. Of course, reality sets in when a financial disaster strikes, such as a major lawsuit. By this time, it usually is too late to take corrective measures.

So by avoiding the exceptions to limited liability for contacts and torts, the small business owner will preserve his legally guaranteed protections, thus securing his personal assets outside of the business.

Further, the small business owner can take actions to limit this limited liability, and thus protect the business's assets as well. A careful understanding and application of authority under contract law, and the pitfalls that can result from contracts and torts, will go a long way toward ensuring maximum asset protection for you and your business.