People form limited liability companies (LLCs) when they want to do business, but have their personal assets protected. Without this type of protection, debts incurred in the course of business could cause creditors to pursue a business owner’s personal bank accounts and other assets.
Therefore, many individuals choose to form an LLC when they start a business. Then, if debts are incurred by the business, the owners’ personal finances are safe. However, the LLC does not provide complete protection. It is important to be aware of some limitations on the protection an LLC provides.
What Does the LLC Protect?
As mentioned above, the LLC protects the personal assets of its members. So, for example, if three people formed an LLC to do business, and the business went into debt, then the LLC’s creditors would not be able to sue the business owners for the money in their personal accounts and assets (unless there are other factors involved—more on that below), but only for the assets owned by the LLC.
A creditor suing the LLC could not recover what they are owed by naming the individual business owners in the lawsuit. The LLC is often referred to for this ability to shield its members from lawsuits.
What Does the LLC Not Protect?
In some cases, a court may decide that the “shield” of the LLC does not cover some of its members for acts they performed or failed to perform. If that happens, then the LLCs creditors become free to pursue the personal assets of the members of the LLC. Those assets would become involved in the lawsuit, and money could be awarded to creditors from those private finances.
When Would Members of the LLC Be Personally Liable?
There are a variety of circumstances under which LLC members may become personally responsible for debts or action of the LLC:
- When the LLC has not actually been formed yet, by filing it with the state in which it exists.
- When one or more of the LLC members personally guarantees a loan or line of credit. Many creditors require that individuals do this, so that they will not be left without recourse to recover funds if the LLC goes into debt.
- When one or more members of the LLC performs an action, acting as an agent for the LLC, which results in some type of injury according to the law.
Essentially, if there is a situation where it is clear that the individual member is more at fault than the LLC as a whole, then it is likely that they could be held personally liable for their actions. If that member is unwilling to come forward, then the court can step in and decide the outcome on a case-by-case basis (meaning that the decision will depend on the facts of the case).
Can an LLC Member Be Held Personally Liable for a Co-Owner’s Actions?
In general, no. It is possible for the LLC to be held liable for one member’s actions, if one member, or an employee of the LLC, is responsible for causing an injury under the law. As an example, if one member causes an injury to another individual due to negligence, and in the course of business, then the injured individual can sue the LLC to recover funds to pay their damages. However, the injured individual cannot sue for the private assets of the LLC members who did not commit the action.
Are There Other Ways For the Creditor to Pursue Personal Assets?
Creditors, of course, do not like being prevented from recovering money that they have lent to debtors when a business fails. Above, we mentioned that many creditors often require individuals to guarantee personal responsibility for loans and lines of credit.
This prevents the LLC shield from protecting private assets. Additionally, a creditor may try to come after the LLC’s assets for an individual member’s personal, non-business-related debts. The creditor may ask a court to:
- Have the LLC pay any money it owes to the member, which the creditor can then pursue, as it is now owned by the debtor; or
- Dissolve the LLC. This would make any assets of the LLC revert to its owners. Once the assets are privately owned by the individual members, they may be pursued by the creditor.
What Else Should I Know About My Liability as a Member of the LLC?
It’s important to be aware that the structure of an LLC is meant to protect its members’ personal assets from each other’s potential wrongdoings. In the case of a single-member LLC, it is not entirely clear how the usual LLC rules apply.
Since there is only one member, there is no one to be shielded from. Additionally, in the case of LLCs that are created for fraudulent purposes, the shield will not protect individual members.
While LLCs are an important business structure and model, it is also important to not abuse the system. Abiding by the LLC rules and ensuring that the LLC is used for the correct, lawful purpose will help avoid many issues of liability.
Do I Need a Lawyer If I Am Facing Liability as an LLC Member?
There is obviously some uncertainty about what the exact rules are with an LLC. While filing the paperwork to form one can be very simple and done without the help of an attorney, it can be more complicated when it comes to the day to day functions of the LLC. Especially if there are questions of proper conduct.
If you are considering forming an LLC, or you already have an LLC but have some concerns, then you could benefit from the advice of a business attorney.