Hey – You can’t sue me! I have an LLC!
One of the primary reasons for forming a business entity is liability protection. In particular, corporations and Limited Liability Companies (LLC’s) protect owners and officers from personal liability. Essentially, the business entity is treated as if it were a separate person apart from the owners and officers. Liability for debts owed by the entity and contracts entered into by the entity falls upon the business entity rather than upon the owners or officers.
Among small business owners, the most popular type of business entity is the Limited Liability Company (LLC). The LLC allows the same liability protection found in a corporation but provides for much more flexibility in business structure, organization and taxes.
Many business owners who form an LLC assume that the business entity will protect them from personal liability in all situations. Unfortunately, this is not true. There are many pitfalls that can trap an unwary business owner, leaving the business owner with significant personal liability on a business debt. This article discusses some of the most common scenarios in which an LLC owner or officer could be held personally liable for the company’s debts.
Tax Forfeiture
A very common mistake among LLC owners is the failure to pay their franchise tax or failure to file an annual franchise tax report. Not every LLC will end up owing franchise taxes. For those LLC’s that do owe a franchise tax, failure to pay this tax can result in the loss of their business entity status and loss of the personal liability protection that had been provided by the LLC. Regardless of whether an LLC is required to pay a franchise tax, the LLC may still be required to file an annual franchise tax report. Failure to file a required franchise tax report can result in the loss of the business entity status and loss of personal liability protection. Therefore, even where no franchise tax payments are due, an LLC owner should take care to make sure that all required reports are filed. Otherwise, unintended personal liability could occur.
When an LLC’s business status has been forfeited, owners and officers of the LLC lose the personal liability protection that had been provided by the LLC. Owners and officers can be held personally liable for debts incurred and contracts entered into when the LLC’s business status is in forfeit. Under certain circumstances, an LLC’s business status can be revived, which will also revive the LLC’s personal liability protection. However, even where the business status has been revived, owners and officers will remain personally liable for debts that were incurred and contracts that were entered into while the LLC’s business status was in forfeit.
Personal Guarantee
Very often, a vendor will ask an LLC to provide a personal guarantor on an account. From the vendor’s viewpoint, there is a certain amount of risk that a company may go out of business without paying the amount due. Asking for a person to agree to guarantee payment adds an additional layer of security for the vendor.
It is important to remember that anyone who signs as a personal guarantor can be held personally liable for the debt. An LLC will not shield you from liability if you have personally guaranteed payment. Even a non-officer employee of a company can be held personally liable if they have signed as a personal guarantor. Therefore, it is important to carefully consider the terms of any vendor agreement before signing as a personal guarantor.
Correct Contract Parties
It is very important to make sure that any contract the LLC enters into makes clear that it is the LLC, rather than any owners or officers, that is making the contract. Any time that you sign a contract on behalf of the LLC, make sure that the signature line reflects that you are signing only as an agent, officer, or representative of the LLC. If it is unclear that the contracting party is only the LLC, an owner or officer signing the contract runs the risk of being held personally liable on the contract.
Personal Conduct
When business lawsuits are filed, it is fairly common to make allegations of fraud, misrepresentation, and deceptive business practices. Where an officer or owner is facing allegations that they personally engaged in this type of conduct, the LLC will not provide personal liability protection.
Separation of Business and Personal
A key reason that business entities provide personal liability protection is because the business entity is considered to be a separate person apart from the owner. For this reason, it is very important to make it very clear that the business entity is something entirely separate and apart from the owner. When the separation between business entity and owner becomes blurred, courts sometimes hold the individual liable. This occurs a surprising amount of the time.
In particular, you should make sure that the business entity has its own separate bank accounts and finances. Do not mix your personal funds with the business entity funds. Do not pay your personal expenses directly from the business entity accounts. Do not pay business expenses or debts directly from your personal accounts. Often, courts view these things as a sign that the business entity is a sham and the owner should be held personally liable.