You know that operating as a sole proprietorship has a lot of risk from audit, liability and paying the most in taxes. Let's address more specifical issues from court cases. As you know partners in a partnership
face a significant risk of personal liability. The same holds
true for sole proprietors. As stated by an Illinois appellate
court, "[t]he universal rule is that the sole proprietor
is personally responsible for the activities of the business."
Georsantas v. Country Mutual Ins. Co., 212 Ill.App.3d 1,
570 N.E.2d 870, 873 (1991). If a lawsuit is brought against such
a business, the suit generally must be brought against the owner
individually and not against the business enterprise. This is
so, since a sole proprietorship has no legal existence apart from
its owner. See Cashco Oil Co. v. Moses, 605 F. Supp. 70
(N.D. Ill. 1985). These rules often leads to harsh results
for the owners of sole proprietorships.
This proved to be the case in Holberg & Co. v. Citizens National Assurance Co., 856 S.W.2d 515 (Tx,
App. 1993). Here, Holberg & Co., a sole proprietorship owned
by Robert Holberg, had an agency relationship with Citizens National,
wherein it sold insurance on a commission basis. Citizens National
brought a breach of contract action against the business, and
received a judgment against it for $94,304.79 plus costs and expenses.
After trial, the trial judge granted Citizens National's motion
to modify the judgment to include Holberg individually. The appellate
court approved this and affirmed the trial court's judgment.
The court stated:
When an individual is doing business under an
assumed name, a judgment rendered against the unincorporated
association is binding on the individual.
Id. at 517 (citing Mustang Tractor & Equip.
v. Cornett, 747 S.W.2d 33 (Tex. App. 1988). This is
the case since unincorporated associations have no legal existence
apart from their members, Cox v. Thee Evergreen Church, 836
S.W.2d 167 (Tex. 1992), and:
[B]ecause a sole proprietorship has a legal
existence only in the identity of the sole proprietor.
Holberg, 856 S.W.2d
at 518 (quoting Ideal Lease Service, Inc. v. Amoco Production
Co., 662 S.W.2d 951, 952 (Tex. 1984).
This is not the case with corporations, which
are deemed in the law to have a separate legal existence apart
from their owners. Because of this, corporate owners are not personally
liable for the corporation's debts or liabilities absent a "piercing"
of the "corporate veil." A sole proprietorship, on the
other hand, does not provide a "veil" at all. Instead,
the business debts and liabilities are those of the owner.
This rule of sole proprietorships is inherent
in the form of the business organization. Some might believe that
a business name such as "X, d.b.a. (doing business as) Y" will relieve them of personal liability. This is not so:
The designation 'd/b/a' means 'doing business
as' but is merely descriptive of the person or corporation who
does business under some other name. Doing business under another
name does not create an entity distinct from the person operating
Dural v. Midwest Auto City, Inc., 425
F. Supp. 1381, 1387 (D. Neb. 1977), aff'd, 578 F.2d 721
(8th Cir. 1978). This rule is universally applied throughout the
country. See, e.g., Pinkerton's, Inc. v. Superior Court, 49
Cal. App.4th 1342, 57 Cal. Rptr.2d 356 (1996); Southern Ins.
Co. v. Consumer Ins. Agency, Inc., 442 F. Supp. 30 (E.D. La.
1977); Wood Manufacturing Co. v. Schultz, 613 F. Supp.
878 (W.D. Ark. 1985); American Express Travel Related Services
Co. v. Berlye, 202 Ga. App. 358, 414 S.E.2d 499 (1992); Krawfish
Kitchen Restaurant, Inc. v. Ardoin,
396 So.2d 990 (La. App. 1981); Jaffe v. Nocera, 493 A.2d
1003 (D.C. App. 1985); Arizona v. Ivanhoe, 165 Ariz. 272,
798 P.2d 410 (1990); Patterson v. V & M Autobody, 63
Ohio St.3d 573, 589 N.E.2d 1306 (1992); Rink v. NPN, Inc.,
419 N.W.2d 194 (N.D. 1988); Thomas v. Colyin, 592 P.2d
982 (Okla. App. 1979); Vernon v. Schuster, 179 Ill.2d 338,
688 N.E.2d 1172 (1997). Thus, to operate a sole proprietorship,
under any name, is to be personally liable for the debts of the
This rule of liability applies even if a business
begins as a sole proprietorship, then converts to a corporation.
For the period of time the sole proprietorship existed, personally
liability attaches to the owner. Normally, if one business entity
succeeds another, the purchasing entity is not liable for the
debts or liabilities of the transferor business. See, e.g.
, Vernon, supra; Leannais v. Cincinnati, Inc.,
565 F.2d 437 (7th Cir. 1977). There are four exceptions to
the general rule, however. The important one for our purposes
is that the new business entity is merely a continuation of the
previous one. That is, the new business has the same ownership
but merely "wears different clothes." See, e.g.
, Vernon, supra; Bud Antle, Inc. v. Eastern Foods,
Inc., 758 F.2d 1451 (llth Cir. 1985); Welco Indus., Inc.
v. Applied Cos., 67 Ohio St.3d 344, 617 N.E.2d 1129 (1993);
Baltimore LuggaRe Co. v. Holtzman, 80 Md.App. 282, 562
A.2d 1286 (1989). In such a situation:
To allow the predecessor to escape liability
by merely changing hats would amount to fraud. Thus, the underlying
theory of the exception is that, if a [business] goes through
a mere change in form without a significant change in substance,
it should not be allowed to escape liability.
Vernon, supra, 688
N.E.2d at 1176 (quoting Baltimore LagRaRe, supra, 80 Md.
App. at 297, 562 A.2d at 1293). Because of this exception, it
would be quite dangerous for someone to begin their business as
a sole proprietorship, with the thought of converting the business
into a corporation at a later time. If in the interim a liability
of the business arises, the owner will be personally liable. The
only way to avoid personal liability is to incorporate at the
One last downside of sole proprietorships is found
in the area of insurance coverage. This was demonstrated in Providence
Washington Ins. Co. vs. Valley Forge. Ins. Co. , 42 Cal.App.4th
1194, 50 Cal. Rptr.2d 192 (1996). Here, sole proprietor Paul Hifai
operated A-1 Rent-A-Car, and also two gasoline service stations
under the name Tennyson Mobil Service. The service stations routinely
provided maintenance for the rental vehicles. One of the rental
vehicles was involved in an accident, injuring nine people. Several
lawsuits were brought upon claims that the vehicle owner negligently
maintained and rented the vehicle.
Hifai tendered the action to his
insurers, but two of the three denied coverage. The trial court
and the appellate court sided with the insurance companies.
One of the insurance companies had issued a commercial
general liability (CGL) policy to Hifai, "doing business
as Tennyson Mobil Service." The other issued a garage operations
policy (GOP) to Hifai, also "doing business as Tennyson Mobil
Service." The CGL policy covered bodily injury caused by
an accident and the GOP policy had the same general coverage,
if the injury resulted from "garage operations." Importantly,
both policies limited coverage for an insured's "owned-autos."
The CGL policy excluded coverage for bodily injury "arising
out of the ownership, maintenance, [or] use" of any auto
owned by any insured. The GOP policy excluded coverage for bodily
injury arising out of "an auto owned or sublet by an insured
while rented, leased or loaned to another."
The business being a sole proprietorship was the
key to the decision. Since such a business has no legal existence
apart from the owner, the court found that Hifai, and not the
business, owned the vehicle involved in the accident was also
was the named insured. Thus, the vehicle was subject to the exclusions
in the CGL and GOP policies, and Hifai had no coverage under these
Many courts have held that the named insured under
insurance policies listing the insured by a trade name or as a "dba" is the individual owner, not the
business enterprise. See, e.g., Allstate Ina. Co. v. Willison,
885 P.2d 342 (Colo. App. 1994); Carlson v. Doekson Gross, Inc.,
372 N.W.2d 902 (N.D. 1985); Purcell v. Allstate Ins. Co., 168
Ga. App. 863, 310 S.E.2d 530 (lg83); OHanlon v. Raftford
Accident & Tndem. Ch., 639 F.2d 1019 (3d Cir. 1981).
Thus, a sole proprietor must exercise extreme
caution in obtaining insurance for his or her business, since
the business has no legal existence apart from the owner. This
is not the case for corporations, which have a separate legal
From all of the above, it can be seen that being
a sole proprietor can present a real danger to your pocketbook.
Every debt or liability of the business is the personal responsibility
of the owner of the business. This liability is inherent in the
form of the business, and cannot be avoided. Operating your business
through an entity that provides limited liability can alleviate
the problem of personal liability.
Questions about Forming an LLC or Corporation?
Call NCP at 1-800-351-5111 (outside the U.S. 1-702-367-7373)