Does incorporating your practice shield you from liability?

This question is one of the more frequently asked questions on professional email lists.  The answer is, “it depends.”  That is not as clear as many would prefer, but it is the right answer.

In fact, there are at least 50 different answers to this question; this is a highly state-specific question and is dependent upon a number of different factors.  Consultation with a local attorney is necessary to get the best answer for your individual situation.

That said, some general information might be of help:

In most “regular” corporations, the directors are shielded from personal liability from the actions of the company.  A properly formed and properly run corporation is considered a legal entity that has an identity separate from the legal identities of the people that direct it.  Although not actual persons, corporations have legal responsibilities similar to that of people.  This means that corporations can accrue debts, make money, exercise rights, etc.

The concept that the corporation has a legal identity separate from that of its directors (and shareholders) is important because it forms the basis of the general principle that the directors of a corporation are not personally responsible for the debts and liabilities of the corporation.

Here’s how this works for most businesses:

Joe the painter, along with his business partners, form a corporation (which they call “Painters, inc.”) for the purpose of providing painting services.  Joe and his partners file the usual articles of incorporation with the State, name themselves as the directors of the corporation, and Painters, inc. then goes about providing services to the general public.  Painters, inc. hires employees, sets up a bank account, takes out a small business loan, and tries to make money.  The directors are paid a salary.  If Painters, inc. makes money, the profits are distributed to the shareholders.  Everything goes fine, until one day an employee of Painters, inc. spills paint all over Customer’s antique couch.  Customer demands $200K, alleging that Painters, inc. (through the actions of its employee) was negligent.  Painters, inc. refuses to compensate Customer, arguing that Customer had promised to move the couch out of the way but didn’t do so.

Customer sues.  But who does Customer sue?  In this case Customer will probably sue Painters, inc., because it was with Painters, inc. that Customer had the contractual relationship.  Because Painters, inc. is a corporation (and legal entity), it can enter into contracts with other legal entities (in this case, Customer).  In addition, Painters, inc. can be held liable for breach of a contract.

Can Customer sue Painters’ directors?  Technically, yes, but it is more difficult.  In most states the directors of a corporation enjoy some protection from personal liability when acting in their official capacities as directors.  Part of the public policy rationale behind this protection is as follows: the state wants to encourage business, and this necessarily involves some risk-taking.  Incorporation allows a venture to (a) take risks independent of its shareholders, (b) exist in perpetuity, and (c) limits the losses of shareholders to that which they initially invested.

If Customer wants to show that a director is personally responsible, Customer will need to show that a director or shareholder abused the liability protections afforded to corporations.  (There are a number of ways to do this, and it is somewhat easier in a small corporation, but it is nevertheless more difficult than just suing Painters, inc..)  If Customer sues Painters for a gazillion dollars, Customer can’t get more than the sum of Painters’ assets.  Thus, corporations are usually helpful business structures for limiting liabilities.  They allow directors to take risks, generate economic activity, and to do so without jeopardizing their personal assets.

So what does all of this have to do with health professionals?

In most states, incorporating for health professionals is somewhat more complicated.  The State often doesn’t allow the directors of corporations to shield themselves from liabilities for their professional activities.  The public policy behind this is important to understand:

The State recognizes that there are significant economic interests in allowing businesses to incorporate and thereby shield directors and shareholders from personal liability, but the state also has an interest in the public safety.  The State’s interest in the general welfare of its citizenry means that (in many jurisdictions) the State doesn’t want health professionals to be able to evade personal liability for their professional activities.  That is to say, the State wants licensed health professionals to think carefully when taking risks. Because of this, most states limit the liability protection that health professionals can receive by choosing to incorporate.

Makes sense, doesn’t it?  Again, this varies a great deal from state to state, but it is helpful to understand the general policy rationale at work: The State doesn’t want you to be shielded from liability for your professional activities.

So why incorporate?  Well, there are still plenty of reasons to incorporate.  Taxes are one reason.  Corporate structures afford some tax advantages in certain situations.  In addition, depending on the state in which you practice, using a corporate structure can still shield directors from non-professional liabilities of the corporation, such as some forms of debt, premises liabilities, etc.  Again, it is critically important to discuss these things with a local attorney and accountant.  The best way to do this is to talk to your accountant and attorney about how you hope to grow your business, and to ask these two professionals to coordinate their efforts.

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