Previously in the Starting a Small Business Series we discussed the importance of limiting your liability as a Minnesota small business owner. In this post we will discuss how small business owners can best limit their liability. The first step to limiting your personal liability is to create a limited liability entity. A local twin cities attorney can help you with that.

Once your company exists, the second step is to create its structure. The most important reason to do this is to avoid personal liability for company debts, also known as “piercing the corporate veil.” In Minnesota, the courts may apply one of three different “tests” to determine whether or not to pierce the veil in any given circumstance.

The Agency Test: under this test a Plaintiff must show that the owner of the business exercised a significant degree of control over the company’s decision making;

The Alter Ego Test: here the court will pierce the veil to prevent fraud, illegality, or injustice, or when not doing so would defeat public policy or shield someone from liability from a crime;

The Instrumentality Test: a Plaintiff must show that the parent company exercises extensive control over the acts of a subsidiary, giving rise to the claim of wrongdoing.

Unfortunately, the courts have done very little to explain these tests. However, the Minnesota Supreme Court did provide a list of factors that they consider when determining whether to look through the limited liability entity. Those factors include: insufficient capitalization for purposes of the corporate undertaking, failure to observe corporate formalities, nonpayment of dividends, insolvency of the debtor corporation at the time of the transaction in question, siphoning of funds by the dominant shareholder, nonfunctioning of other corporate officers and directors, absence of corporate records, and existence of the corporation as merely a façade for individual dealings. To complicate matters further, the Court has said that in addition to a number of the previously mentions factors being present, there also must be an “element of injustice or fundamental unfairness.”

What all of this amounts to for the Minnesota small business owner is that they must not only create their business, but they must observe the organizational formalities imposed by state law. They must do things such as elect directors, adopt bylaws, elect officers, adopt banking resolutions etc. While it may seem silly for a single member business to hold a meeting as the sole member of the board, and then another as sole shareholder (or sole Member if an LLC), this is what is required under Minnesota law for a small business owner to protect themselves from personal liability.

Any twin cites attorney can help the small business navigate these confusing waters, and it is highly recommended that you consult one before moving forward with your business transactions.