This article was contributed by Daniel Sierra who works as a writer and advisor at Farmerbrown.com.
A Limited Liability Company (LLC) is a great way for entrepreneurs and business owners to protect their assets and maintain independence, combining both benefits of sole proprietorships and partnerships while still being able to operate as just one entity.
It is the most common business structure, covering its owners from personal liability (e.g., business loan debts). An LLC’s regulation varies in each state, and forming it usually requires basic knowledge of business law or a staunch attorney-client relationship with a reputable legal practitioner from any law firm. This ensures that business owners have the necessary guidance along the line.
LLC offers personal liability protection to owners and saves business assets from personal creditors. Most states have no restrictions on who can become LLC members except for banks, insurance companies, and other business entities exempted under the state’s regulation.
Limited liability entities protect owners from being held personally responsible for the company’s debts. It prevents the loss of personal assets due to bankruptcy or lawsuits. It also eliminates the chances of double taxation by allowing profits to be passed to an LLC owner directly and taxed as personal income.
However, there are cases where you can be held personally liable if the LLC fails to protect your personal assets. We look into the cause of such cases below:
If an LLC owner or member personally guarantees the company’s obligations, such individuals will be held liable for the debt. The LLC won’t suffice as a coverage shield in this case. Thus, to prevent this, its owner and members must always act in the LLC’s name when entering financial agreements or signing contracts. Careful reading and checking properly the loan documents to understand terms can also prevent owners from losing their personal assets. LLCs do not cover personally guaranteed obligations. Even General Liability Insurance won’t offer protection against signed agreements.
Piercing of Corporate Veil
A court can pierce the corporate veil to impose the company’s debt on the LLC’s members or co-owners. This happens when a small business fails to notice certain corporate formalities like keeping board minutes, separating personal finances from the company’s own, adopting bylaws, and holding regular board meetings. This could also result from the LLC’s engagement in reckless acts, fraudulent conduct, or when the liability company is inadequately capitalized from inception. This may prompt the court to declare such LLC a sham, and the LLC’s member will be held liable for the liabilities.
Personal Wrongdoing or Negligent Act
Injury, assaults, or fraud that result from your own negligence is treated as personal liability, and you’ll be held personally liable for the consequences. An LLC member can be a victim of this case if he/she acts under his own name and not the LLC’s name. Every LLC member must carry appropriate liability insurance to prevent losing personal accounts, investments, and any other personal assets to these liabilities.
What to do if you are sued with an LLC?
A proper liability insurance policy can cover both you and your business in cases where the coverage for the company is limited. Any legal actions accusing you of wrongdoings can have devastating financial consequences on your personal assets if they’re personal liabilities. This could be negligent building maintenance, wrecking work vehicles, or defrauding customers. Thus, ensure you stay protected with insurance as preparation for possible accidents or mistakes.
Things to consider before setting up an LLC
One of the first things to consider when setting up your LLC is whether it will work as a separate entity or not. It is advisable to set it up as a separate legal entity to avoid possible liability. Corporate law stipulates that any shareholder that mixes personal assets with corporate assets may be held personally liable as the “alter ego” of the corporation. This is known as the alter ego theory.
Thus, consider the possibility of separating personal credit cards and bank accounts from that of the LLC. Also, ensure every document carries the LLC’s name and is signed on its behalf. This could save you from alter-ego liability by clearly indicating to your business partners that they’re dealing with an independent entity, and not you.
Another essential thing to consider beyond the LLC’s mode of setup is your potential liability risks and the possible protection you can get from the LLC. Hence, carefully review the following:
LLC’s Personal Liability Debts
If you don’t personally guarantee any debt payment, you won’t be personally liable for the LLC’s debt. This prevents creditors from going after your personal property. They can only go after your company’s assets.
LLC’s Co-owners and Employees’ Actions Personal Liability
LLC protects owners from any personal liability or misconduct by a co-owner or member during the course of business. However, if the LLC is found liable for the owner’s negligence, creditors can take the LLC’s money or property as pronounced in the judgment against the LLC, but the owner won’t be personally liable for the debt. Also, the owner’s personal liabilities do not affect members and co-owners.
Personal Liability For Your Actions
The liability provided by LLCs does not cover your personal wrongdoings during the business. You’ll be held responsible for intentional fraud, failure to deposit withheld taxes from employees’ wages, third-party injury due to negligence, crashing a company truck, etc.
LLC’s Liability for Members’ Personal Debts
Creditors of an LLC owner are prohibited from taking the LLC’s asset to satisfy the owner’s debt. Various states have stipulated ways the creditors may follow to collect stipulated payments from such an owner. They are:
- Getting a charging order from the court. This order instructs the LLC to pay the creditor the total amount due to the LLC’s owner.
- Foreclosure of the LLC’s owner ownership interest or
- Getting the court to dissolve the LLC.
The first approach isn’t usually applicable to single-member LLCs as they are not eligible for charging order protection, so creditors may use any other remedies against the sole member. Also, some states do not clearly state whether a single-member LLC should receive the same liability protection from the owner creditors as multi-member LLCs. Considering these things alongside your state’s regulations can help you form a successful LLC.
An LLC is a great way to protect yourself and your business from potential lawsuits and can save you a lot of money in the long run. If you’re looking for some extra peace of mind when it comes to your business, an LLC might be a good option for you. Also, make sure to reach us at ContractorsLiability.com to keep learning about insurance tips, guides, and how it can take care of your business assets.
About the author
Daniel Sierra is writer and advisor at Farmerbrown.com who enjoys helping people make better financial decisions for them and their businesses. With an experience on Business Management and focusing on risk prevention, he is able to write practical advice for anyone attempting to successfully navigate their finances. His work has been featured on publications from Levelset, PropertyCasualty360, and Benzinga. Daniel writes about the ups and downs of business insurance for entrepreneurs.