Incorporating your small business to avoid liabilities? You may be surprised to learn that you are not as safe as you think.

Please God... don't let my business get sued!

Please God… don’t let my business get sued!

It is my nearly universal advice to all business owners to incorporate to limit their liabilities. But even though I advise incorporating, it may do you no good. You may be surprised to learn that you can still be liable for torts, employment law actions, and debts.

When I tell my clients this, they usually argue with me.

But I keep all the bank accounts separate!”

“But I thought that was the whole point of incorporating!”

“Why bother to incorporate at all???

Good question! Let me explain.

A tortfeasor is usually personally liable for their torts even when they commit the tort while at work or in the name of a business. The business may also be jointly liable. And when you own a very small business, and that business commits a tort, there have been some cases in California that state that the owner of the business is also considered the individual tortfeasor. Since it is hard to put that last sentence into English, let me give several examples.

Let’s say your are a small business. You bake and deliver cakes. You have only a couple employees. You have a cake to deliver one day and you do it yourself. While driving the cake, your run a red light and hit another car. Even though you were on business, you are also personally responsible for that act of negligence. The fact that you are incorporated does not relieve you from personal responsibility.

In contrast, let’s say you are the same baker, but you have 100 employees. One of your employees is delivering a cake, runs a red light and gets into an accident. You do not know that employee well, had no reason to think he would drive negligently that day, and did not even know he was going out to deliver that cake. In that situation, the company and the employee may be liable, but not the business owner personally.

And another example: you are the small business cake baker again. You send an employee out to deliver a cake, but know that he’s a terrible driver, it’s snowing heavily outside, and think he is likely to get into an accident because the delivery is late and he is going to drive hurriedly. But you send him anyway. In that case, depending on a number of factors, you may be personally liable when he blows through that red light, despite the fact that you are incorporated.

Similar rules apply to debts (when they are incurred in bad faith or fraudulently, both of which are torts) and certain employment actions (i.e. sexual harassment, which is sort of like a tort).

Some of this makes sense to me — you shouldn’t be able to commit fraud and then hide behind your corporation. But with respect to negligence and certain torts like trespass and conversion, I feel like they create an unfair burden on small businesses that does not exist against big businesses. Sometimes, if you are a one-man-band, or even just a small shop (like most small businesses are), being incorporated may do you no good if you get sued.

But that being said, it is still worth incorporating. Why? Because of all the things it does protect you against. For example, most wrongful termination claims are still only against the company and not the owner. Most wage claims are charged against the corporation and not the owner. Most debts are charged against the corporation and not the owner (barring a personal guaranty, of course). And there is even some coverage for torts.

If you are a small business owner, you should still be incorporated. But it’s a little like taking shelter in a house with a leaky, hole-filled roof. It’s better than no roof. But you should regularly evaluate practices to see how you can improve your chances of not getting drenched in a heavy rain. And you should buy insurance…. (an umbrella policy???)