Risks of Getting Sued With an LLC

by David Carnes
The exact rules for forming an LLC vary by state.

The exact rules for forming an LLC vary by state.

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The LLC, or limited liability company, is a form of business organization that is recognized by the governments of all 50 states and the District of Columbia. Although the LLC form offers investors a degree of limited liability that is moderately superior to that enjoyed by a corporation, investors do not enjoy airtight protection. LLCs themselves face significant potential liability.

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Limited Liability

Absent special circumstances, an LLC creditor cannot sue investors for an LLC debt -- instead, it must sue the LLC itself. If the LLC's assets are insufficient to cover the debt, the creditor is normally out of luck. In addition, an LLC is exempt from many formalities that corporations must observe -- it need not appoint a board of directors, for example, and it need not keep minutes of meetings. Corporations, by contrast, may have their limited liability revoked for consistent failure to observe these formalities.

Alter Ego Liability

"Alter ego" liability is a legal exception to LLC limited liability protection that arises when the LLC is managed in a way that fails to distinguish between the investors and the LLC itself. A court may invoke this exception in favor of a creditor and allow him to sue investors on an LLC debt if, for example, the LLC co-mingles LLC funds and the investors' personal funds, or if investors commonly withdraw money from the LLC's treasury for personal uses.

Personal Liability

Notwithstanding limited liability, an individual investor is liable for his own wrongful acts committed while conducting LLC business. He may be sued for defrauding an LLC client, for example, or for negligent billing practices. In many cases, parties loaning money to an LLC will require investors to guarantee the debt in their personal capacities, allowing them to be sued on the debt if the LLC defaults.

The Doctrine of Respondeat Superior

The doctrine of respondeat superior is a long-standing and fundamental legal document that holds employers civilly liable for wrongful acts committed by employees acting within the scopes of their duties. If an LLC investor who is also employed by the LLC defrauds an LLC customer, for example, the customer may sue both the employee and the LLC. In the case where an investor-employee negligently causes a traffic accident during his lunch break, however, the LLC might offer the defense that the investor-employee was not on duty at the time of the accident.