People who decide to incorporate usually have high expectations about the protection they will enjoy from being incorporated and believe that a corporation will protect them personally from all types of liability.
We can start by looking at contractual liability. As a separate legal entity a corporation is like a person in terms of what it can and can’t do. This includes entering into contracts. Of course a corporation can’t do anything unless someone acts on its behalf, e.g. a director, officer, employee or agent, but when a corporation enters into a contract it is the corporation that is party to the contract and is legally bound by its terms. This means that if a corporation breaches a contract the other party’s claim is against the corporation – not the shareholders, directors, officers, employees or agents of the corporation. This also means that if the other party is successful in its claim only the corporation and it’s assets are at risk – not the personal assets of its shareholders, directors, officers, employees or agents. In this way a corporation can protect you and your personal assets from its contractual liabilities. Only what you put into the corporation or what is created within the corporation will be at risk.
For example, let’s say that Tom incorporates a business and becomes the sole shareholder and director and also the President. He then negotiates a contract on behalf of and in the name of his corporation whereby it agrees to deliver product to a purchaser. The product arrives damaged and the purchaser decides to sue the corporation for breach of its contract and is awarded damages in the amount of $25,000. If the corporation is unable to pay the $25,000 then the purchaser may decide to pursue its other remedies by going after the corporation’s assets but can’t look beyond the corporation and its assets and get to Tom or his personal assets. In other words, by incorporating his business Tom has protected himself personally from the purchaser’s lawsuit.
Legal Tip: Make sure that if you incorporate your business, you enter into contracts in the name of your corporation and make it clear to the other party(ies) that when you sign the contract you are simply signing the contract on behalf of the corporation as its authorized signatory and not in your personal capacity. This is important in order to preserve your contractual liability protection.