Many people use a business entity such as a limited liability company or corporation to keep personal assets and business assets separate. Owners, officers and employees of a business arent normally liable to the businesss creditors. Thats good, because the last thing you want is to have your personal assets on the hook. There are, however, quite a few ways to lose that protection. One is failing to properly review and sign a contract on behalf of the business.
This can be disastrous. Two years ago, the Minnesota Court of Appeals ruled that the former owner of a failed paint store was personally liable for business debts. Thats not abnormal. If you own a limited liability company or a corporation, chances are that you probably have had to give personal guarantees for the business in the past. Thats often the price of being a business owner, since banks, landlords and other major creditors want to know that there are assets available in case things dont work out. But that shouldnt be the case for all contracts signed by a business owner, and it definitely shouldnt be the case for employees. It also shouldnt come as a surprise if theres a problem, like it did for the paint store owner.
He failed to carefully read a lease and didnt notice that it included a personal guarantee. The lease didnt have a separate signature block for him as an individual, and there was no separate document that created the personal guarantee. In an unpublished opinion, the court held that the owner was personally liable for both unpaid rent that accrued during the term of the lease after his business failed, but also for double rent for each month after the lease expired and inventory remained in the store. This resulted in a personal judgment of just over $100,000. The same situation could easily arise in a purchase agreement, a construction contract or any number of other documents.
Here are a few pointers on how to avoid that risk. Unfortunately, this doesnt apply to all businesses and, as mentioned above, frequently wont apply to business owners. If your business is a general partnership or a sole proprietorship, you dont have the luxury of separating business liabilities from your personal assets. If you are in a limited partnership, you may have some protection if you are the limited partner and are not actively managing the business. Consult an attorney if you have questions about protecting personal assets from business liabilities.
When contracts are in dispute, courts generally look at the document itself to figure out what the parties intended. If it isnt clear whether the parties to the contract were the businesses, individuals or a mix, there is a chance that someones personal assets may be available to creditors. Remember that if theres no ambiguity in the contract, courts wont look at other evidence, such as what the other party to the deal told you, to figure out who is liable. Your understanding of the deal and what the other party told you wont matter.
There are a few easy steps you can take to help make sure that personal assets arent at risk.
Verify the parties to the contract
First, make sure the contract is between the proper parties. Its surprisingly easy to get this wrong. Most businesses file documents with state governments when they are created. In Minnesota, for example, a limited liability company files articles of organization at the Office of the Secretary of State. A corporation files articles of incorporation. In Wisconsin, documents are filed with the Wisconsin Department of Financial Institutions. These documents give the proper legal name of the business, which should be used in the contract. Failure to use the proper business name can be evidence that the contract was really signed by an individual in their personal capacity.
While you are at the appropriate state government Web site, take a moment to make sure that all the businesses involved in the contract are in good standing with the state.
Businesses can also operate under a different name than the formal name that appears on the documents filed with the state. In that case, youll be looking for a certificate of assumed name or some other document that links the name under which the company is doing business to its full legal name. The name could also be written in the contract with a signal that it is doing business under another name. This is typically shown by the letters dba, which stands for doing business as.
Sign on behalf of the business
Make sure you sign in a proper signature block. A signature block memorializes the agreement by showing that the parties intend to be bound by the terms of the contract. A proper signature box starts with the name of the party that is signing the document. The businesss full legal name should appear both here and at the beginning of the contract. Next, there should be a line for a signature. The individuals full name should be typed under that line. Finally, the individuals title should be indicated. Heres an example:
My Great Idea LLC
By: Full Name
What you dont want to see is just a single blank with your name. That could be used as evidence that you signed the document in your personal capacity, and not on behalf of the business.
Read the contract thoroughly
Always carefully read the entire contract. Make sure that it has everything you expect and no surprises. Entire books have been written about what to look for in a contract, so theres no way to give a comprehensive overview in this article. Since were reviewing how to keep your personal assets safe from business debts, Ill just mention one. Look for any language that would create a personal guarantee.
A simple sentence in a purchase agreement like the undersigned personally guarantees the obligations of the purchaser is enough to put your own assets at risk. Thats true even if you are not named as an individual party to the contract and the signature block is for your business. This is what went wrong for the paint store owner mentioned above.
This article should not be taken as legal advice. As always, seek advice from a lawyer if you have questions about agreements. These are the kinds of problems that you want to catch in advance.
John Gasele is an attorney at Fryberger, Buchanan, Smith & Frederick, P.A., practicing in the areas of corporate, administrative law, trademark and copyright law. You can reach him in the firms Duluth office at 218-722-0861.