Separate Legal Entity
State laws treat LLCs as independent legal entities separate from their owners, who are known as members, and managers. LLCs basically receive the same treatment in the court system that corporations receive. Judges create this “legal fiction” to protect shareholders, directors and officers and promote commerce. Along those lines, LLCs may build credit with financial lenders, enter into contracts and sign leases.
One primary benefit of forming an LLC is that it protects the personal assets of individual members. That means the LLC members cannot be held liable for the debts and other liabilities of the LLC. If a plaintiff successfully sues an LLC and obtains a money judgment against the LLC, the plaintiff generally cannot go after the members’ personal bank account or other assets. In addition, lenders who extend credit to LLCs, generally cannot go after the members to collect the LLC’s debts. The courts refer to this kind of liability protection as the “corporate veil.”
Piercing the Corporate Veil
The liability protections that an LLC provides are not absolute, however. In some cases, courts will use the doctrine of “piercing the corporate veil” to allow plaintiffs to obtain LLC members’ personal assets, typically when LLC members engage in some type of fraudulent behavior. State laws vary from state to state in this respect, but some common factors exist to which many courts look in determining whether to pierce the corporate veil. Courts look at whether one or more member misuse the company’s funds by co-mingling personal and company bank accounts or simply use large amounts of company money for personal use. Courts may also look at the LLC’s capitalization. LLC’s with very little capital and large debts may raise a red flag for some courts. Courts consider piercing the corporate veil if one or more members used the LLC to engage in fraud. Above all, courts typically make this decision based on a highly fact specific examination on a case by case basis.
Many state laws limit the ability of service professionals to limit their liability by creating an LLC. Service professionals typically include doctors, lawyers, accountants and architects. Some states prohibit these types of business from forming LLCs. Other states require that they form professional limited liability companies (PLLCs), which may have different rules than regular LLCs. In addition, many states allow service professionals to form LLCs or PLLCs, but prohibit the business entity from limiting their liability for professional malpractice.