The excitement of launching a business can be as overwhelming as the day-to-day demands of making the new venture work. At the outset, it can be difficult to imagine that a new product, vendor deal or client account could lead to complications that would put your personal assets or, worse yet, the personal assets of your loved ones at risk.

The Million Dollar Judgment

This is the kind of nightmare scenario faced by business owner Nicola DiCosola and his wife when an appellate court affirmed a $1.2 million judgment against DiConsola as an individual. In Fontana v. TLD Builders, an Illinois construction company founded by DiCosola was sued when it contracted to build a home, but failed to complete the work and eventually abandoned the project. DiConsola’s wife held all of the company’s stock and was the company’s sole director, but at trial could not specify the details of any of the company’s transactions.

Although the construction company had filed incorporation papers, the court pierced the corporate veil and found DiConsola personally liable for damages, citing a number of factors including lack of proper financing, failure to pay dividends to the stockholders, commingling of corporate and personal assets, lack of a functioning officer or director, and the failure to keep proper records or observe other corporate formalities. The case does not discuss the ramifications of the judgment on DiConsola’s wife, who was not named in the suit, but the judgment gave the plaintiffs access to DiConsola’s personal assets, which would have included any assets held jointly by the DiConsolas.

Piercing the Corporate Veil

A business owner’s decision to incorporate or file for LLC status is an important first step in protecting personal assets from liability, but as cases like Fontana v. TLD Builders show, the reality is that corporate status is not an absolute shield. A business owner can be sued as an individual, putting into risk personal assets such as homes, cars, pension plans, wages, annuities, bank accounts and investment portfolios.

Personal liability arises when a business owner or any of its employees personally injures someone, engages in fraudulent, illegal or reckless conduct, fails to properly pay taxes, or fails to maintain corporate formalities (such as by mingling personal and corporate assets in a single bank account). Consumers and employees may bring charges against business owners for a variety of claims, including claims for product liability, unfair and deceptive business practices, wrongful discharge and sexual harassment. Likewise, vendors and other creditors may pursue a business owner as an individual if the company defaults on an account or mortgage that the business owner guarantees personally.

Your Spouse’s Assets at Risk

The operation of a business exposes a business owner to the possibility of being sued in tort or contract for a variety of claims. Depending on the circumstances, it may also be possible for a business owner’s spouse to be held responsible for losses and liabilities associated with the business. Spousal liabilities under debtor-creditor law vary from state to state and depend on a number of factors, including how the claim arose, whether the spouse is directly or indirectly associated with the claim, and the type of personal assets at stake.

• Spouse Directly Involved in the Business. If a spouse guarantees a business debt or directly participates in business activities that lead to liability, the spouse will be responsible for judgment claims and can be pursued by creditors as an individual.
• Spouse Indirectly Involved in the Business. Even when a spouse is not directly involved in the company’s affairs, a court may find the spouse liable as an agent or implied partner of the business owner. For example, a spouse who isn’t on the computer payroll but assumes an active role in the business may be named in a suit. The law in this area is very fact-specific, and if a creditor decides to name a spouse in the suit, the court will examine the extent of the spouse’s involvement through the often-lengthy process of trial.
• Passive Spouse. A passive spouse won’t be held personally responsible for the satisfaction of money judgments against the defendant spouse. However, creditors can often reach the property and income belonging jointly to a married couple, known as community property. Some states such as Louisiana and California do allow judgment creditors to reach community property. Other states such as Texas only allow creditors to access community property in contract cases.
• Special Protection for Jointly-Held Properties. Many states also recognize a general exception for certain kind of joint estate available only to married people, known as a tenancy by the entirety. If a property is held by both spouses under a tenancy by the entirety, it cannot be seized to satisfy a judgment.

Taking Protective Measures

It is possible to distribute personal and business property in a way to avoid or minimize the reach of creditors in case the business faces hardship. Certain categories of assets are by default exempt from the reach of creditors even in a bankruptcy proceeding, and other categories of assets may also be exempt if a debtor successful files for an exemption. Consultation with an attorney specializing in corporate law may be helpful in developing a strategy for structuring personal and professional assets. Planning ahead ensures that the possibility of financial crisis is not only unthinkable, but remote.

-By Dava Casoni, Annie Lin