When starting a business, a major concern is what the owners’ personal liability will be. Owners are concerned that if their business makes a mistake, not only could they lose their investment, but they could lose their home and other personal assets. Some business organizations, such as sole proprietorships, offer no liability protection; if the business lacks the funds to settle a debt, the owner must make up the difference. Generally a limited liability company (LLC) is different; the owner is not personally liable for the business’ obligations and therefore cannot be sued for the business’ actions. However, there are some situations where the owner of an LLC can be sued personally for the LLC’s actions.
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To qualify as an LLC, the owners of the business must file organization documents with the state where the business is located. If the state grants the business LLC status, the business becomes a separate legal entity from the owners. This means that in any lawsuit the business can be named as a defendant. The owners can work for the LLC and receive distribution of funds from the business. An LLC generally has fewer managerial formalities than a corporation, which can also protect its owners from being personally liable for its obligations.
Piercing the Veil
If the LLC acts as a “veil” protecting the LLC’s owners from the business’s liabilities, a court may “pierce the veil” and allow an owner to be named as a party to a lawsuit in certain circumstances. The court will pierce the veil when the LLC is being used to do something illegal or if there is no real distinction between the owners and the LLC. So if an owner commits fraud while acting as an officer for the LLC and then seeks to use the liability shield to protect himself from being personally liable, a court will generally not permit that. This issue also arises if the owner interacts with someone on behalf of the LLC but does not make that clear to the third party; if the third party brings suit related to that interaction, the owner can be named as a defendant.
Protecting Against Piercing
An owner can take several steps to prevent being sued for the LLC's actions. The first and most obvious step is to not participate in any fraud or illegal activity. In addition, an owner should be clear when he is acting on the LLC’s behalf by referencing the business numerous times during any dealings with a third party. Financially speaking, the business and its owners should maintain separate financial accounts and records and never co-mingle funds. If there are any distributions from the business to the owner, it should be clearly recorded in both the LLC’s and owners’ personal records. Finally, when organizing the LLC, the owners should ensure that the business is properly capitalized. This means that the LLC’s assets and income must be sufficient to pay the debts and obligations it expects to incur.
Another example of when an owner can be sued personally for a business obligation is if the owner personally cosigns a business loan. As a cosigner, the owner would share liability for paying off the debt, and therefore could be named as a defendant in any suit by the lender to obtain what is owed.