One of the most significant benefits to organizing a business as a corporation is that it protects the officers and shareholders from personal responsibility for their actions on behalf of the corporation. Ordinarily, an officer cannot be held personally liable, as long as he is acts within the scope of his authority and within the bounds of the law. The only exception to this protection is if a case can be made that the corporate entity is merely a shell that the owners are using to defraud the public.
A corporation is an independent legal entity. Once articles of incorporation are filed with a state business registrar, the entity comes into existence as a legal person that can do most of the things that a real person can do. The state statutes that authorize the formation of corporations also authorize them to own property, buy and sell goods and services, pay income taxes and litigate in court, all in the corporation's own name. In practice, this means that officers and directors manage the affairs of the corporation, but they are doing so on the corporation's behalf.
The law expressly provides limited liability for officers, directors and shareholders acting on behalf of the corporation. An injured party or a creditor cannot sue corporation employees for actions they took in the corporation's name. For example, if an officer signs a loan document on behalf of the corporation and the corporation defaults, the lender's only recourse is to recover the loss from the assets of the company. The lender cannot ordinarily sue the officer personally to recover the money, for example by attaching his house.
There are instances where officers and directors are exposed to liability that arises through corporate actions. The most common areas of personal liability touch on actions that officers and directors take that are not specifically authorized or are negligent. For example, if an officer gets into an accident while driving the company car, the other driver will sue the company but may also sue the officer if he went through a red light. Limited liability applies only to actions that the company authorizes. Negligent or illegal actions are rarely found to be within the scope of a person's employment. To guard against situations resulting in personal liability, corporations often take out insurance policies for its officers and directors, which will cover events that might cause personal exposure.
Piercing the Corporate Veil
The other instance when a officer can be held personally liable for corporate obligations is in the case that a court "pierces the corporate veil." If a court finds that owners of a corporation operated it like a personal piggy bank, intermingling personal and business affairs to the detriment of third parties, it will disregard the usual rules that establish the corporation as an independent entity. In cases such as this, creditors would be allowed to pursue personal assets of the people involved.
Read More: Corporation vs. Officer vs. Owner
Terry Masters has been writing for law firms, corporations and nonprofit organizations since 1995, specializing in business topics, personal finance, taxation, nonprofit issues, and general legal and marketing content creation for the Internet. Terry holds a Juris Doctor and a Bachelor of Science in business administration with a minor in finance.