A key benefit of limited liability companies is that the owners (or “members”) receive limited liability; that is, they can usually not be held personally liable for the debts of the LLC. In addition, if the LLC is sued, the owners’ personal assets are not subject to collection.
However, there are some instances when — as lawyers say — the veil of limited liability is pierced and the LLC members can be personally liable for the debts of the LLC.
Personally Guaranteeing a Business Loan
Some owners of new, small LLCs will be required by banks to personally guarantee a business loan. If a loan is personally guaranteed, the owner is liable for the debt if the LLC cannot pay it. Debts that are not personally guaranteed may be extinguished by the LLC’s bankruptcy, but if the owner co-signed for the loan, the owner is personally responsible.
Misuse of Funds or Commingling of Assets
If an LLC member misuses the LLC’s funds for inappropriate personal purposes, such as making a purchase or transferring money to a personal account, the LLC’s creditors may have the ability to collect debts directly from the member. Commingling of funds occurs when a member mixes money belonging to himself and money belonging to the LLC with insufficient records to determine which funds belong where.
An owner who intentionally transferred money out of the LLC to himself in an attempt to avoid a debt or a pending lawsuit against the LLC would also probably be held personally responsible.
LLC Member Fraud
If an owner or member commits fraud in the course of business, that member may be held personally liable. Incidents of fraud would include entering into debt with the intent never to pay back the loan or misleading anyone as to the financial state of the LLC. In some cases, operating an LLC that is underfunded or heading toward bankruptcy could be considered fraud.
Poor Maintenance of LLC Records
One of the duties of LLC members is to maintain adequate business records. Though LLC requirements are much more lax than corporation requirements, an LLC owner may be liable for what is called a “disregard of formalities” of proper records in line with state requirements are not kept. Ignoring the terms in the operating agreement, disregarding note-taking during member meetings, and failure to maintain financial records could all make an LLC owner personally liable.
LLC Member Liability
A member may only be held liable if three things can be proved: (1) the plaintiff can prove that the LLC served the interests of the member rather than the member serving the interests of the LLC, (2) that a member breached a duty required by law, and (3) that the plaintiff suffered a financial loss as a result of the breach of duty.
If the plaintiff — who could also be a creditor holding one of the LLC’s loans — can prove these three elements, the individual member will be held personally liable. This does not mean that the member will face criminal charges; only that any excess debt that the LLC cannot afford will be attributed directly to the owner.