How a Corporation can Eliminate or Minimize Personal Liability

Contact Neufeld Legal PC for your incorporation legal work at 403-400-4092 / 905-616-8864 or Chris@NeufeldLegal.com

The legal recognition of a corporation as a separate legal entity generally shields its owners (shareholders) from personal liability for the corporation's debts and obligations. The legalities of this separation has been explained by the courts through the legal concept of the corporate veil. However, this protection is not absolute. To maintain and minimize personal liability, a corporation and its owners must take several crucial steps.

Step 1: Uphold the Separation Between the Corporation and the Owners (Avoid Piercing the Corporate Veil)

The single most important concept is to operate the corporation as a truly distinct entity. Failure to do so can lead a court to "pierce the corporate veil," which removes the limited liability protection and holds shareholders or directors personally liable.

Key Corporate Formalities to Maintain:

  • Avoid Commingling Funds (Absolutely Critical): It is imperative that you do not mix personal and business finances.

    • Maintain separate bank accounts and credit cards for the corporation.

    • Do not use the corporation's funds or assets for personal expenses. If the owner needs money, it should be done through a documented salary, dividend, or loan.

  • Maintain Adequate Capitalization: The corporation must be funded with enough capital (money, equipment, etc.) to reasonably carry out its intended business and meet its anticipated obligations. Undercapitalization is a common factor in piercing the corporate veil cases.

  • Observe Corporate Governance: Follow all statutory requirements for a corporation in your state:

    • Hold and Document Meetings: Conduct regular (annual and special) meetings for the shareholders and the board of directors.

    • Keep Accurate Records/Minutes: Document all significant corporate decisions, votes, and resolutions, and keep them in a corporate record book.

    • Adopt and Follow Bylaws: Ensure the corporation's governing documents (Articles of Incorporation, Bylaws) are adopted and the corporation operates in accordance with the rules set out in those documents.

  • Proper Use of Corporate Name: Always conduct business and sign documents (contracts, leases, checks, invoices) in the full, legal name of the corporation, not the owner's personal name.

Step 2: Specific Protections for Directors and Officers (D&Os)

While shareholders are generally protected from corporate debts, Directors and Officers (D&Os) can face personal liability for failing to perform their duties or for their own wrongful acts.

  • Fulfill Duties of Care and Loyalty: D&Os must act honestly and in good faith with a view to the best interests of the corporation (Fiduciary Duty), and must exercise the care, diligence, and skill that a reasonably prudent person would (Duty of Care).

  • Maintain Due Diligence: D&Os should stay informed, attend board meetings, review financial and legal reports, and seek professional advice (legal, financial, industry experts) on complex matters. This helps demonstrate that they acted prudently and with due care.

  • Obtain Directors' and Officers' (D&O) Liability Insurance: This is a critical safeguard. D&O insurance protects the personal assets of directors and officers from financial losses resulting from claims of wrongful acts, mismanagement, or breach of fiduciary duties.

  • Provide Indemnification: A corporation's bylaws should include provisions to indemnify (legally protect and compensate) its D&Os against expenses and liabilities incurred in lawsuits, provided they acted in good faith for the corporation.

  • Avoid Conflicts of Interest: D&Os must disclose any potential conflicts of interest to the board and abstain from voting on related matters to avoid claims of self-dealing.

Step 3: General Risk Management and Contractual Measures

These actions serve as a layer of protection for the corporation's assets, which indirectly protects the owners by preventing the corporation from becoming insolvent.

  • Obtain Business Insurance:

    • General Liability Insurance: Covers claims of bodily injury, property damage, or advertising injury.

    • Professional Liability (Errors & Omissions) Insurance: Covers claims arising from negligence or mistakes in professional services.

    • Product Liability Insurance: For companies that manufacture or sell products.

  • Avoid Personal Guarantees: Do not personally guarantee corporate loans, leases, or contracts unless absolutely necessary. A personal guarantee overrides the corporation's limited liability protection, making the owner directly responsible for the corporate debt.

  • Use Contracts to Limit Liability: Include clauses in business contracts to limit the amount of damages a party can claim or require disputes to be resolved through faster methods like arbitration.

If your business is seeking experienced professional legal representation with respect to incorporating a new corporation or dealing with the corporate legalities impacting your company, contact us at 403-400-4092 [Alberta], 905-616-8864 [Ontario] or via email at Chris@NeufeldLegal.com.


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