We received several questions after our post about sales contracts. If you’ve ever been asked to sign something for your company, you may have wondered if you personally were going to be held accountable. If you are setting up a company, how do you avoid personal liability? And if you have legal questions, when should you seek the counsel of a lawyer?
Some terms to know:
- Entities and designates: Entities are the parties (people or companies) involved in a contract. Their designates are people signing on the person’s or company’s behalf.
- Breach: When one or both parties fail to meet the obligations outlined in a contract, one or both has breached the contract, which could lead to damages outlined in the contract or stipulated through arbitration or court proceedings.
- Waiver: This is a clause that essentially gives up a usual claim or right to damages. You agree to waivers all the time and may not realize it. Your gym probably has a liability waiver you signed when joining.
It’s natural to be a little nervous about signing a contract, especially one over which you do not have complete control. Working with a lawyer who understands what is reasonable and can explain any unfamiliar legal language can help. It may make you feel more comfortable signing documents or accepting legal provisions that at first seem unnecessary without context, said Heather Harper, a clinical professor of law at Chicago-Kent College of Law and the supervising attorney at its Entrepreneurial Law Clinic. She told us that a common question is what to look for in a lawyer.
“My advice is always the same: You need to feel like your lawyer is listening to you, appreciates your risk, and can work with you to mitigate business risks. A good lawyer explains the relevant issues in a clear and accessible way and helps work with the business team to accomplish business objectives,” Harper said.
“I advise people seek counsel at any time when they don’t understand the legal implications of what they’re signing or agreeing to,” she said.
The best times for an individual employee to seek a lawyer’s help are when they are receiving equity compensation, when they are leaving a company and being offered severance, and when they are presented with restrictive covenants (such as noncompete clauses or promises of confidentiality) that limit future work.
“There are lots of other reasons to see a lawyer, and most of the time it’s for an employee to understand and get comfortable with compensation or other employment conditions,” she said. It doesn’t have to be a bad thing or something contentious.
The corporate veil
Who has the authority to enter into contracts depends on the type of entity and can generally be designated by the business owners. It is important for small business owners and founders to discuss their authority and how to designate it, Harper said.
To the question of how do I know if I have authority to sign this contract?, Harper answers with a question of her own: How do you not know?
Generally, all this is spelled out in a company’s founding documents. Often in the beginning, one person is responsible for signing all contracts, and the company will be legally bound to the terms. Over time, that may become cumbersome so several other people are designated. As the company grows, more and more people will be given this responsibility for contracts large and small that fall in their area of management.
“Corporate governance is a big topic, but the most important thing to remember is that businesses should always have founders agreements to protect the company,” Harper said.
Founders agreements come in different forms but are essentially a series of documents whereby owners of a company set initial expectations and provide consequences for failing to meet those expectations.
“It’s a great way to set a strong base for a successful business relationship and mitigates the single biggest risk in early-stage startups—founders’ disputes,” she said.
One way individuals protect themselves is by setting up their businesses as limited liability companies, indicated by LLC at the end of the name. Owners, directors, officers, and employees of a properly formed company with liability protection are able to shield themselves from personal liability arising from the operation of the company’s business. A limitation of liability will not protect an employee or owner from his or her own bad acts or fraud, but it does mean that a business owner can run a business without fear that a liability arising from tort or contract will personally bankrupt the owner, Harper said.
To take advantage of limited liability, business owners need to treat the company separately from their personal assets, respect corporate formalities, and meet certain criteria.
There is a body of law on “piercing the corporate veil”—placing personal liability on company officers and directors, and holding them responsible for the actions of the company—but the need for it is rare. It is only done to avoid injustice or fraud, she said.
If you have more legal questions, please ask. IAW is happy to dig up broad answers. If you have specific questions, take Heather Harper’s advice and ask an attorney.