Real estate owners and developers often form limited liability companies (LLCs) to hold title to property. One key reason for making the switch is that LLCs limit personal liability — only the LLC members’ equity investments are usually at risk. While these entities do offer protection from personal liability for the debts and liabilities of the entity itself, some exceptions exist that could drain an owner’s or developer’s personal finances.
Environmental liability is a common concern when purchasing property. The use of an LLC to make the purchase does not make that concern moot. The Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA) imposes strict, joint and several liabilities — no showing of negligence or intent is required — for cleanup costs on past and present owners and operators of facilities where hazardous materials have been released. An LLC member who had the authority to control the operations or decisions involving the disposal of hazardous substances could be held liable for cleanup.
To avoid this dire consequence, any potential environmental issues should be carefully considered and investigated before entering the contract.
Personal Guarantees and Contracts
LLC members who personally guarantee the company’s debts or obligations will be held liable for their nonpayment or breach. This is a true risk when entering contracts or financing agreements before the LLC legally comes into existence because the other party insists on some guarantee.
To minimize the risk of personal liability, always act in the name of the LLC. When you sign contracts, for example, do so solely as an agent of the LLC, making sure to identify the LLC as the principal in the document. Similarly, make sure that the LLC’s other agents and employees act as representatives of the entity and not of you personally. For extra protection, members might consider adding a personal umbrella policy to the LLC’s traditional business insurance coverage.
Certain loan defaults may also create personal liability. Carefully review all loan documents to make sure you completely understand the consequences of all potential covenant violations.
An LLC will not protect a member from liability for his or her own negligent or otherwise wrongful acts that cause injury to another, such as assault or fraud. That could include negligent hiring or supervision of employees if an employee causes some type of injury and the member hired the employee in his or her own name, rather than in the name of the LLC.
Also note that, if an LLC member or employee commits a wrongful act that causes injury while acting as an agent of the LLC, it is not just the agent’s personal assets that could be targeted by the injured victim. The victim could also go after the assets of the LLC, under a theory of vicarious liability (also known as “respondeat superior liability”) for its agent’s acts.
A Pierced Veil
On rare occasions, a court will “pierce the corporate veil” to impose liability for an LLC’s debts and obligations on its members. This typically occurs when closely held and small businesses fail to observe corporate formalities such as holding regular board meetings, keeping minutes, adopting bylaws and ensuring company finances are separate from those of members. It could also happen if the LLC engaged in reckless conduct or fraud or was inadequately capitalized from the beginning. In all of these circumstances, a court might conclude that the LLC is merely a sham to shield its members from liability.
LLCs come with their benefits, but they do not provide a total defense for members’ personal assets. The rules governing LLCs vary from state to state. Consult with your attorney and financial expert to devise asset protection strategies for your individual needs.
If you have additional questions regarding LLC investments, please contact Kadir Sunardio at [email protected] or call him at 312.670.7444.