The members of a limited liability company (LLC) have, obviously, very limited liability. Indeed, limited liability is one of the primary reasons why individuals select the LLC business structure. However, the liability shield of members in a limited liability company is not absolute.
Limited liability protects the individual assets of the LLC members. Thus, the debts or claims against a company cannot be recovered by joining the members of the company to a lawsuit. Furthermore, the debts or claims against the individual member cannot be recovered by joining the company to a lawsuit. Thus, it is often said that the LLC acts as a "shield."
The LLC liability shield may not extend to the acts or omissions of company members, or may be disregarded altogether. In either case, if the court determines that the liability shield does not protect the individual, then a creditor may proceed to attach the personal assets of the individual member to a lawsuit or judgment.
There are three basic instances where a creditor or claimant may argue that the acts or omissions of a LLC member prevents the liability shield from being extended to the member:
- The LLC that has not yet been formed
- The member, acting as an agent of the company and without giving notice that they are acting on behalf of the company, causes an injury that is recognized by the law
- The member, acting as an agent of the company and without giving notice that they are acting on behalf of the company, guarantees a contractual obligation
Determination of liability will be governed by the law of the state in which the entity is formed. Since LLCs are created by state statutes, states can condition, restrict or disregard the limited liability. Most LLCs are analogous to corporations, and as such, courts have usually applied the same standards for disregarding the limited liability protection of corporations to LLCs. These standards are typically put through what is referred to as a "Three-Prong Test." Although the Three-Prong Test will be applied to LLCs, the factors may differ. These factors typically include whether:
- Articles of Organization and annual reports have been filed and any fees have been paid
- There is a single member or multiple members
- The LLC has its own Employee ID Number and maintains bank accounts and facillities separate from the members
- The LLC has manifested ownership interests in intellectual property, real property, and office equipment
- The LLC has entered contracts under its own name
- The LLC has concluded an operating agreement.
This is a very gray area of law because many factors are considered to determine whether a member has lost the protection of a liability shield. Seeking out the services of a business attorney will greatly assist in determining whether you can attach the personal assets of a LLC member in recovering on a lawsuit, or whether you as an LLC member will be protected.