Limits of Business Liability: from share capital to personal assets

Limits of Business Liability: from share capital to personal assets

Starting a business comes with a series of risks, and one of the most critical aspects is understanding how far liability extends when the business incurs debts. In Spain, the legal structure you choose—whether as a sole trader or through the formation of a company—determines whether business obligations are covered only with the company’s capital or whether they could endanger the entrepreneur’s personal assets.

This article explores the key differences depending on the legal form, strategies for protecting personal assets, and the exceptional circumstances in which the so-called “corporate veil” may be lifted.

Differences between a Limited Liability Company and a sole trader

One of the most significant decisions when starting a business is choosing whether to operate as a sole trader or to form a company. For sole traders, there is no legal separation between the individual and the business. This means the entrepreneur is liable with all present and future personal assets for any obligation arising from the business, as established in Article 1911 of the Spanish Civil Code.

In contrast, creating a Limited Liability Company (Sociedad Limitada or S.L.) establishes an independent legal entity. This means that shareholders are not personally liable for company debts, but only up to the amount of their capital contributions. Although the previously required minimum share capital was 3,000 euros, Law 18/2022 of September 28 reduced this to just one euro to encourage entrepreneurship. However, when capital is less than this amount, the law imposes additional safeguards, such as the obligation to allocate profits to reserves until 3,000 euros are reached or requiring further contributions if the company is liquidated and unable to pay its debts.

In short, while sole traders bear unlimited liability, an S.L. offers a legal shield that, under normal circumstances, protects the personal assets of its shareholders from the business’s financial obligations.

How to Protect Personal Assets

Protecting personal assets is a constant concern for any entrepreneur. An effective first step is to choose a legal structure that limits liability, such as an S.L., even for solo-run businesses. This structure creates a legal boundary between business and personal assets.

Another option is to take advantage of the Limited Liability Entrepreneur (ERL) figure, introduced by Law 14/2013 to support entrepreneurs. This figure allows sole traders to protect their primary residence from business-related debts, provided certain conditions are met, such as not having used the home as collateral and registering it as exempt from business liability.

Beyond legal structure, it’s essential to maintain strict separation between personal and business finances. Using separate bank accounts, keeping organized accounting records, and avoiding any asset confusion are crucial for preserving the protection that limited liability provides.

Insurance is also a key tool. Professional liability insurance can cover damages to third parties, while Directors and Officers (D&O) insurance protects against potential claims resulting from business decisions. These policies can be decisive in the event of litigation.

Another important point is to avoid personally guaranteeing business debts. Although banks often request personal guarantees, doing so effectively waives the protection of personal assets. Whenever possible, alternative arrangements should be sought or guarantees limited in scope.

Lastly, the matrimonial economic regime can also play a role. If married under a community property system, business debts may affect jointly owned marital assets. For this reason, many entrepreneurs choose a separation of property regime to avoid unwanted consequences.

The corporate veil doctrine

Although limited liability is one of the primary advantages of forming a company, this principle is not absolute. In exceptional situations, courts may apply the “piercing the corporate veil” doctrine. This legal concept allows judges to disregard the separation between the company and its shareholders when the entity has been used fraudulently or in bad faith.

Spain’s Supreme Court has recognized this possibility in cases of legal fraud, abuse of legal personality, asset commingling, or using a company as a mere façade to avoid liabilities. For example, if a shareholder uses company funds for personal expenses or creates a business without adequate resources solely to contract and avoid payment, courts may hold the shareholder personally liable.

A well-known example involves entrepreneurs who, after incurring debts, strip the company of its assets, transfer their shares to insolvent third parties, and resign from management. In such cases, courts may find an abusive use of corporate personality and lift the veil to protect creditors.

However, this remedy is limited and must be applied with caution. Not every business failure or mismanagement justifies lifting the veil. Courts require proof of intentional wrongdoing or gross negligence that results in economic harm to third parties.

In conclusion, understanding the limits of business liability is essential for any entrepreneur or SME. Choosing obligations and structure, complying with legal and fiscal obligations, and managing diligently are key to safeguarding personal assets. In case of doubt, seeking specialized legal advice is the best way to start and grow a business with security and peace of mind.