This article is written by Chandana Pradeep, from the School of Law, University of Petroleum and Energy Studies, Dehradun. This article analyzes whether the personal assets of an individual would be affected due to a business being sued.
A business while being formed has to go through all the necessary procedures according to the legislations which has been enacted, but one aspect that is not thought of at the initial stages is what the liability would be on the people who have invested in a business and if their assets will be at risk or not in the event of the company being sued? This article seeks to analyse the extent of it.
When can you sue a business?
A company that is registered under the Companies Act, 2013 has a separate legal entity from its members, this is one of the core features present, which makes it clear that a company can enter into contracts by itself and also can be sued and can sue. There are many scenarios when a business can be sued, they are the following:
- If they have terminated an employee on illegal grounds or without any reason.
- Breach of a contract or a warranty entered by the company.
- An individual who faced any sort of harassment or discrimination.
- If a company has given wrong information about itself concerning the financial status or any other related aspect.
- If the company has caused any injury to any individual.
What type of lawsuits can be initiated against businesses?
According to the description, a company can sue and be sued, it can be sued based on different types of lawsuits, some of them are based on:
- A breach of contract
- Personal injury
- Tax fraud
- Violation of laws
The process of how a company should be sued depends on what type of company it is, whether it is a sole proprietorship, a company, a limited liability partnership or any other type of company.
Are Personal Assets affected?
When a business is being sued, it can be done for various reasons and if personal assets will be affected once the business is sued, is dependent upon the type of company it is.
In the case of a company being sued, the directors are the main persons in authority. A director is defined as a director appointed on behalf of a company according to Section 2 (34) of the Companies Act 2013. The company though by law is given the scope of a juristic person, cannot take its decisions by itself and the directors are the ones that make decisions that are beneficial for the company.
Though the board of directors are the decision-makers, the company is a separate legal entity from the board of directors, so when a company is sued, a director’s personal assets will not be affected, as they are separate from the assets that the company owns.
In the case of Tristar Consultants vs. M/s. customer Services India Pvt. Ltd. & Another(2007), the director of the company had to pay off the debt of the company, and it was clearly stated that “Directors of companies have been described as agents, trustees or representatives of the company because of the fact vis-a-vis the company they act in a fiduciary capacity. They perform acts and duties for the benefit of the company. Thus, directors are agents of the company to the extent they have been authorized to perform certain acts on behalf of the company.”
The directors are bound to have any duty of care or otherwise to any third party which has agreed with the company. However, there are exceptional cases when it is proved that it is the director’s negligence that caused the company to be sued. There are certain cases where a director will be personally liable, such as:
- Misrepresentation– A director will be personally liable if the director giving false information and thereby misrepresenting the creditor and the creditor gives loans or any other loss is suffered by the creditor
In the case of Mukesh Hans & Anr. Vs. Smt. Uma Bhasin & Ors, it was held that It is equally well settled that a Director of a Company though he owes a fiduciary duty to the Company, he owes no contractual duty to third parties. There are, however, two exceptions to this rule. The first is where the Director or Directors make themselves personally liable, i.e., by the execution of personal guarantees, indemnities, etc. The second is where a Director induces a third party to act to his detriment by advancing a loan or money to the Company. On the third-party proving such fraudulent misrepresentation, a Director may be held personally liable to the said third party. It is, however, well settled that this liability would not flow from a contract, but would flow in action at tort, the tort being of misrepresentation and of inducing the third party to act to his detriment and part with money.”
- Personal guarantee, assurance, indemnity– The director will be personally liable if he has done the following, which gives any sort of personal guarantee, assurance or indemnity to a third party, then upon suing the company will not be liable but the director will be personally liable.
- Personal Benefit– In cases where the director has gained any sort of personal benefit in the capacity of the companies name, then if there arises a situation where the company issued, the director will be the only one liable.
Other situations where a director will be held personally liable are
- Tax frauds– In case, there have been any tax frauds or the company has not been paying up the tax and it cannot be retrieved by the company, the director is personally liable under the Income Tax Act, 1961.
- Dishonoured Cheque- A director is personally liable if a company dishonours a cheque once it has been issued if it has been done on the interest, or negligence by the director of the company.
Limited Liability Partnership
A business that is a limited liability partnership is governed under the Limited Liability Partnership Act, 2008. Just like the name suggests, there is only limited liability in this form of business. This type of business lies somewhere between a company and a partnership and has pros and cons accordingly.
A limited liability partnership is similar to a company is given a status of a distinct legal entity and treated as a person, which means that they can own properties, enter into contracts etc and do various other activities which an individual can do so, but if the limited liability partnership is sued, the partners’ assets will not be affected, as they are the personal assets of the partners and not of the limited liability partnership company.
A limited liability partnership has the features of being a separate legal entity and can be perpetual. In this type of business, the extent of liability is dependent on the contribution that is done by each person. The directors of this type of business, just like in the scenario with companies are treated as agents of the limited liability partnership.
However, if personal liability comes into question, then if the partner has done something which is their fault caused by negligence or wrongdoing they will be personally liable and not the other partners who are present in the company.
Partners are personally liable for the business obligations of the partnership. This means that if the partnership can’t afford to pay creditors or the business fails, the partners are individually responsible to pay for the debts and creditors can go after personal assets such as bank accounts, cars, and even homes.
For example, if the partnership dissolves and there are still outstanding debts to suppliers or lenders, those creditors can sue you personally to pay for the debts. Debts of the partnership will expose your assets to liability unless you’re a limited partner, in which case your liability is limited to the money you’ve invested.
Though the partners of this type of company are the only liability on a limited basis there are exceptions as well where there is unlimited liability given to the partners and they are:
- Fraud- In cases of fraud, the unlimited liability cap is removed and the person committing the fraud has unlimited liability over the same. If it found out that a partner worked with with the intent to defraud a creditor, then they will be personally liable if the limited liability partnership proves that they were not having the knowledge of the same and the partners who defrauded the creditors have to indemnify the creditor according to Section 30 of the Limited Liability Partnership Act,2008.
Many business owners set up a sole proprietorship because it has many advantages compared to that of while forming a company or any other type of company. The advantages of being a sole proprietorship include that it is easy to form a company through a sole proprietorship, not much capital needs to be raised in a sole proprietorship compared to that of a company, etc.
But this type of company has its cons as well, there is no distinction between personal assets and business assets, and if a business is sued, that means the personal assets will also be included in the companies assets to recover the creditors’ damage.
Method of protecting assets
There are methods to protect personal assets in some types of companies, they are the following. In the case of a sole proprietorship, the owner can always change the type of company to a limited liability partnership or a company to avoid personal assets being involved in the scenario of the business being sued.
Then there is a concept of Asset protection trust, which is mostly used in the United States of America, but it is gaining fast recognition in India too in recent years. The purpose of this form of trust to be invoked is The purpose of an asset protection trust is to insulate assets from creditor attack. These trusts are normally structured so that they are irrevocable for a term of years and so that the trustmaker is not a current beneficiary. An asset protection trust is normally structured so that the undistributed assets of the trust are returned to the trustmaker upon the termination of the trust provided there is no current risk of creditor attack, thus permitting the trustmaker to regain complete control over the formerly protected assets.
Once a business is being sued, the question of whether the personal assets will be at risk or not depends upon the type of company the business is and it varies accordingly. In the case of an unlimited liability partnership and a sole proprietorship, the personal assets are at risk as there is no distinction between the unlimited liability partnership assets and that of the owners or partners’ assets.
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