The reading level for this article is All Levels

Given that an LLC or C-corp exists as an autonomous business entity that exists independently of the owners’ personal credit, one of the first questions many business newbies will ask is, “what is the owner accountability to business liability if he remains safe while the business is allowed to go belly up?”

Part of the reason why this seems so confusing to most of us is because we are familiar with a system of incentives that suggests that an individual will always act in order to self-maximize, and if the environmental conditions for his doing so allow him to spend at the expense of others (in this case, a bank or shareholders), then surely the likelihood of his doing so should present a significant threat to the lending agencies that are backing the business. We consider the problems that come with personal home loans (especially in the light of recent economic events) and think that the same difficulties should apply to business.

Well, this is not entirely accurate. It should be understood that business lenders are marketing their services to a slightly different kind of borrower, and weight their lending practices toward lenders that are especially credit-worthy and interested in long term constructive business practices. This is why the downpayment requirements are so much higher for business loans. Banks are very careful to lend their largest sums of money to businesses that have existed for a long time and show a reasonable projection of long-term profitability, so that they minimize the chances that the capital they lend out will be squandered. This simple method of selection ensures that the loans that are issued have high owner accountability to business liability.

Also, it should be remembered that not all of the owner’s actions are taken on the business’s behalf; if an owner acts in an irresponsible or illegal manner or personally injures someone, action is usually taken against the owner himself and not the business. The legal system provides very strict boundaries between what is and is not within the realm of owner accountability and what the business itself is accountable for.

While abuses of the system do happen from time to time, it is important to remember that the system has been around for a while, and has stood the test of time.

This Business article was written by Mark Karavan on 1/1/2010