Separate Legal Identity
As a creature of state statute, an LLC is afforded a distinct legal identity separate from that of its owners or “members.” As such, an LLC, like a corporation, can enter into contracts with third parties. However, the owner of an LLC, similar to a shareholder in a corporation, is not personally liable for the debts of the business. Although an LLC is not a corporation, members of an LLC should be aware that in certain circumstances, courts have disregarded the corporate identity and have held individual shareholders liable for the debts of the business.
Piercing The Corporate Veil
Under certain circumstances, creditors may be able to hold shareholders of a corporation personally liable for any business debts incurred through a process known as “piercing the corporate veil.” In order to prevent fraud or injustice to third parties who execute contracts with a corporation, courts will perform an analysis to determine whether the corporation has been utilized by its individual shareholder(s) in such a manner that in terms of substance, no separate legal entity was in fact maintained.
Corporation As Alter Ego
In cases where individual shareholders act in a manner inconsistent with an intent to accord a separate legal identity for the corporate entity, courts may conclude that the corporation functioned merely as the “alter ego” of its individual shareholders.
Preservation Of Corporate Identity
The most common occurrences that usually support a finding that shareholders treated the corporation as their alter ego are failure to observe corporate formalities and commingling of corporate assets with those of individual shareholders. Although LLC’s are generally not obligated to rigorously observe corporate formalities incumbent on traditional corporations, members of an LLC would be well advised to segregate the assets of the LLC from those of its individual members. Members of an LLC should maintain a separate bank account for the company, as well as keep separate books and accounting records for the business.
Members of an LLC should be aware that if they fail to take steps to maintain the company’s distinct identity separate from those of its members, many courts might disregard the LLC’s legal identity and hold the individual members personally liable for the debts of the business. Maintaining a separate bank account for the LLC is one indication that the owner intended to maintain a separate and distinct legal identity for the LLC and not use the enterprise as a dummy or shell corporation for the purpose of defrauding creditors.