If an LLC Is Responsible for Debt, Who Pays if They Cannot?

By Jeff Franco J.D./M.A./M.B.A.

Operating a business as a limited liability company, or LLC, definitely has advantages over operating it as a sole proprietorship or partnership. The most notable advantage is the limitation on members’ personal liability for the business debts of the LLC. However, there are circumstances in which members may have to pay business debts when the LLC can’t.

LLC Separate From Members

A LLC is separate and distinct from its members, which means that members aren’t responsible for paying outstanding business debts when the LLC is unable to generate enough earnings and doesn’t have sufficient assets to liquidate. This is because the only recourse state laws provide LLC creditors is money and property that belongs to the LLC rather than its members. Keep in mind, however, that any contribution of cash or property to the LLC that a member makes, or has an obligation to make, immediately becomes LLC property and can be used to satisfy outstanding business debts. Moreover, a creditor can also obtain a judgment to intercept profit distributions that would otherwise be payable to members. In contrast, if the business were set up as a general partnership rather than a LLC, creditors could look to the personal assets of partners to satisfy business debts.

Member Guarantees

For most new or smaller businesses operating as LLCs, obtaining the necessary capital may require loans and other lines of credit. However, most creditors will require one or more members to guarantee repayment. When an LLC member acts as guarantor, the creditor can pursue the guarantor’s personal assets if the LLC fails to satisfy its payment obligations. In this case, there is no separation of liability between the LLC and the member-guarantors.

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Contractual Debts

Debts can come in many forms and include the debts an LLC incurs because of contracts it enters into. Just as with other debt obligations of the LLC, members aren’t responsible if the LLC breaches business contracts. However, it’s important – especially for single-member and smaller LLCs – that the members with authority to sign contracts on behalf of the LLC ensure that all contract terms bind only the business. In addition, when LLC members sign their names, it must be clear that they are signing in their capacity as LLC members only. For example, if you only sign your name, it’s possible that the other party can collect any court-awarded damages resulting from the LLC’s contract breach from you, the member who signed the contract. To avoid this scenario and preserve the limits on member liability, you should always sign using language such as this: “John Smith, as member of Acme, LLC.”

Acts of Members

Members of a LLC don’t automatically have the authority to enter into transactions on behalf of the LLC without the consent of other members, unless the authority to do so is stated in the LLC operating agreement. When an unauthorized member enters into a contract on behalf of the business and the LLC is unable to void the contract for some reason, other LLC members may seek reimbursement from the unauthorized member for all costs the business incurs.

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What Financial Liability Does Each Member of an LLC Accrue?
 

References

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