There are a number of advantages associated with incorporation, most of which are based on the fact that the corporation is a separate legal personality. Today, let us have a look at the topic of limited liability – one of the most prominent pros of incorporation, at least at the first look.

As the corporation represents a separate legal entity, its shareholders are not liable for corporate debts and obligations – in other words, the corporation is fully responsible for its own wrong conduct. The shareholders’ liability is limited only to the amount they have paid for their shares. If the corporate assets are not sufficient to satisfy the obligations, the debt cannot be derived from the shareholders.

In view of the above, there is no doubt that limited liability is one of the most attractive qualities of the corporation – sometimes to a degree that it becomes the main reason for choosing to incorporate. However, such an advantage can often be seen as an illusion, because funders and creditors of a small, not-distributing corporation will always look for the ways to protect their investments. Any fund-providing institution will insist that certain principals of the firm (the president, the major shareholder, etc.) should give some guarantees to ensure indebtedness of the corporation. This effectively eliminates any advantage of limited liability for those asked to sign such a guarantee, as limited liability is lost when personal guarantee is given.

At the same time, the concept of limited liability seems very attractive in case of unexpected liability – for example, if a corporation employee causes another injury due to neglect. In accordance with the law, in such cases of unexpected liability the injured party does not have a right to either derive any financial advantage from the shareholders or sue them. Similarly, if the corporation fails to honour its contractual obligations, the shareholders do not have to provide compensation. Also, the principle of limited liability is usually applied to the relationship between suppliers of materials and the corporation: the suppliers cannot legally obtain any personal commitment from shareholders, nor can suppliers turn to shareholders for payment if the business becomes insolvent.

Sometimes even this amount of limited liability could be in question, because now the courts are more willing to look behind the corporate veil and hold the principals liable for the obligations of their corporations. In many cases, the court decision will largely depend on the reputation of the corporation – on its any taint of wrong actions or avoidance of honourable obligations.