A common misconception among owners of incorporated business owners is that they have no personal liability in the event of a product liability claim. Probably 65% of all the incorporated start-up businesses that contact me tell me they would not purchase product liability insurance if their vendors or distributors didn’t require them to.
Corporations exist to help protect the personal assets of the shareholders and directors from personal liability for the actions or liabilities of the corporation. But it is extremely dangerous for smaller privately-held businesses that sell or manufacture products to assume they are free of all personal liability.
The legal concept of “piercing the corporate veil” can often be used to make the shareholder, directors and officers personally liable for the debts or liabilities of the corporation.
Unlike larger businesses, smaller businesses are more susceptible to having the corporate veil pierced. Smaller corporations, that have no product liability insurance, often hold few or no assets. A plaintiff or injured third party may seek to hold liable a shareholder, director or officer with more assets. Large corporations typically have more assets available and a legal staffs to help them avoid the technical issues. This is how they avoid having the corporate veil pierced.
Wikipedia has identified the following factors that courts consider when piercing the corporate veil:
- Absence or inaccuracy of corporate records;
- Concealment or misrepresentation of members;
- Failure to maintain arm’s length relationships with related entities;
- Failure to observe corporate formalities in terms of behavior and documentation;
- Intermingling of assets of the corporation and of the shareholder;
- Manipulation of assets or liabilities to concentrate the assets or liabilities;
- Failure to pay dividends
- Non-functioning corporate officers and/or directors;
- Other factors the court finds relevant;
- Significant undercapitalization of the business entity (capitalization requirements vary based on industry, location, and specific company circumstances);
- Siphoning of corporate funds by the dominant shareholder(s);
- Treatment by an individual of the assets of corporation as his/her own;
It’s important to note that not all of these factors need met in order for the court to pierce the corporate veil. Furthermore, some courts might find that one factor is so compelling in a particular case that it will find the shareholders personally liable.
If you are a small business and incorporated to separate your personal and corporate assets, it is important to have both General Liability and Product Liability insurance. In the event you are sued, your lack of corporate assets isn’t motivation to pierce the corporate veil and expose your personal assets.
On the other hand, if you have few corporate or personal assets, then you may consider rolling the dice and not having General Liability or Product Liability insurance. When there is little chance of recovery or restitution by the injured third party, you become a less attractive target for a lawsuit.
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