Podcast Episode 9—Why Use a Business Entity?
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Podcast Episode Timestamps
00:00 — Topic
00:32 — “Filing entity” defined, some of the types, its basic purpose, and how it is treated legally
02:50 — Why not simply buy insurance? The “your work” exclusion example.
04:27 — Veil piercing and alter ego
05:40 — Tex. Bus. Org. Code 21.223(a) limitation in the contractual context
06:58 — Return to the subject of signing business contracts properly
07:42 — Return to the subject of personal guarantees
08:11 — Final thoughts, how to ask questions or read the related blog post, and outro
A “filing entity” can be a corporation, LLC (limited liability company), or other corporate form that serves as a liability veil, shield, or forcefield between claims of folks who interact with the business and the individuals who own and run the business.
After you set up your business, look back at the earlier blog post and podcast episode to ensure you are properly signing business contracts.
What’s the Point of a Business Entity?
Starting a business is inherently risky. But, society benefits from entrepreneurs taking business risks. So, one way society incentivizes (or aims to decrease the disincentives) of starting a business is by helping entrepreneurs manage their risks by forming business entities (such as LLCs and corporations) that, generally, limit the downside risk to the assets of the entity.
These are formally referred to as “filing entities” because paperwork needs to be filed with the Secretary of State to form the entities. Filing entities are distinguished from non-filing entities such as sole proprietorships and general partnerships.
After a filing entity is formed, it is treated as a person, even though it doesn’t eat or breathe. But it does conduct business and is treated as separate from its owners and the folks running it. Effectively, this insulates the assets of the owners and managers of the business from satisfying debts of the entity and should prevent the individuals from being included in any lawsuits related to the operation of the business.
What About Insurance?
Insurance is a very important part of most businesses’ risk management strategies. But, it isn’t foolproof. I’m reminded of a case where an insured person who provided services in people’s homes had a customer complaint where they alleged a worker had damaged the wooden floor’s surface. When my client presented the claim to the insurance company, they denied coverage under the “your work” exclusion. They said that coverage was denied because the alleged damage was related to my client’s work. Everyone thought that was what she had been paying premiums for!
What about Veil Piercing or Alter Ego?
Piercing the corporate veil was a legal remedy developed for situations in which the use of a business entity would be considered abuse of the corporate shield or “veil” in a way that would be unjust for claimants and creditors. But, like many areas of law, the pendulum swings – from too much corporate protection to too little. Perhaps because owners and operators of entities (especially small businesses) were being included too often in business lawsuits under alter ego theories, the Texas legislature stepped in with Tex. Bus. Orgs. Code § 21.223(a) to greatly reduce the availability of veil piercing and alter ego in situations related to contractual obligations. Now, to pierce the corporate veil in situations related to a contractual obligation, the plaintiff (the person asserting the lawsuit) must show that the corporate form was “used for the purpose of perpetrating and did perpetrate an actual fraud on the obligee primarily for the direct personal benefit of the” individual. This is a high hurdle.
What if I Sign My Business’s Contracts Wrong?
First, know that most contracts will not lead to a lawsuit in which the terms and parties are scrutinized for inclusion in the lawsuit. Second, the information in episode seven of the Keith Law, PLLC Podcast focused on what I view as best practices on signing contracts on behalf of your business entity to minimize risk of personal exposure.
What About Personal Guarantees?
As mentioned in episode seven of the Keith Law, PLLC Podcast, sometimes personal guarantees make sense. But, without a filing entity, you are essentially providing a personal guarantee for every transaction and contract.
Deciding to go into business demonstrates that you are a risk taker. But, to be wise in business means calculating and managing risks. One of the first ways to manage your risk it by using a filing entity to conduct business.
Disclaimer: This audio and blog post are for informational purposes only and should not be misinterpreted as legal or other professional advice. If you have a legal question, you should consult with an attorney in your jurisdiction. Thank you for tuning in to Keith Law, PLLC.