Limited Liability

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Limited liability is a legal principal that means the owners of a business are not liable for the debts of a business.  The owners of businesses that lack limited liability are personally liable for all the debts of the business.

For example, if an LLC with limited liability loses a lawsuit and owes the plaintiff $1 million, only the assets of the LLC are available to satisfy the $1 million judgment. If the LLC only has $200,000, the plaintiff can only collect that amount, even if the LLC’s owner is worth $1 million or $1 billion. Conversely, if a sole proprietorship without limited liability owes $1 million, the sole proprietor will have to pay out of pocket, regardless of how much money the business itself has.

Limited liability is a distinction between business entities on the one hand and sole proprietors and general partnerships on the other. Business entities generally afford their owners and operators limited liability, while sole proprietorships and general partnerships do not.

Business entities with limited liability can lose that liability if the creditor can “pierce the corporate veil.”

The opposite of limited liability is personal liability, in which the owners of a business are personally responsible for the business’ debts.

Example of Limited Liability

Acme LLC is an incorporated entity. In particular, it is a limited liability company. It has one owner, Bob. Because Acme is an LLC, Bob has limited liability for Acme’s debts.

Acme has assets worth $500,000. Aside from his ownership of Acme, Bob has other assets worth $1,000,000. Combined with his ownership interest in Acme, Bob has total assets worth $1,500,000.

An Acme customer slips and falls at Acme headquarters. Acme loses a lawsuit and owes the plaintiff $1,250,000. The plaintiff takes all of Acme’s $500,000 in assets, but cannot take Bob’s personal assets because he is shielded by the company’s limited liability. Having lost all of Acme’s assets as well as his own, Bob still has his own $1,000,000. He only lost the $500,000 invested in Acme, but keeps all of his personal assets.

Example of Personal Liability

Acme is an unincorporated business, meaning it is not an incorporated entity. It has one owner, Bob. Because Acme is an unincorporated entity, Bob has personal liability for Acme’s debts.

Acme has assets worth $500,000. Aside from his ownership of Acme, Bob has other assets worth $1,000,000. Combined with his ownership interest in Acme, Bob has total assets worth $1,500,000.

An Acme customer slips and falls at Acme headquarters. Acme loses a lawsuit and owes the plaintiff $1,250,000. After taking $500,000 from Acme, the plaintiff can take $750,000 from Bob. Having lost all of Acme’s assets as well as his own, Bob now has assets worth only $250,000 – a personal loss of $1,250,000.

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