LLC: When Does It Not Protect Your Personal Assets?
Limited liability companies (LLCs) are common ways for real estate owners and developers to hold title to property. Their popularity is due, in part, to the fact that LLCs limit members’ personal liability. In other words, only an LLC member’s equity investment is usually at risk, not his or her personal assets. However, this does not mean personal liability never exists for the LLC’s debts and liabilities. Below are some of the exceptions that may risk an owner’s or developer’s personal finances.
Making personal guarantees and contracts
If an LLC member personally guarantees the company’s debts or obligations, they will be held liable for the LLC’s default on that debt. This is more common they one might think. Many LLC members enter into contracts or financing agreements on the LLC’s behalf before the LLC legally comes into existence, if the other party insists on some guarantee.
- Always act in the LLC’s name. When you sign contracts or financial agreements, do so solely as an agent of the LLC, making sure to identify the LLC as the principal in the document;
- Make sure that the LLC’s other agents and employees act as representatives of the entity, not of you personally;
- For extra protection, members might consider adding a personal umbrella policy to the LLC’s traditional business insurance coverage; and
- Carefully review all loan documents to make sure you completely understand the consequences of all potential covenant violations, as certain loan defaults may also create personal liability.
Piercing the corporate veil
On rare occasions, a court will pierce the corporate vail to impose liability for an LLC’s debt 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 board minutes;
- Adopting bylaws; and
- Ensuring company finances are separate from those of members.
It could also happen if the LLC engages in reckless conduct, 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. Once a court makes that decision, LLC members’ personal assets can be used to satisfy LLC liabilities.
Paying for environmental clean-up
Environmental liability is a common concern when purchasing property, and using an LLC to make a sale or purchase does not eliminate that concern. The Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) imposes strict joint liabilities for clean-up costs on past and present owners and operators of facilities where hazardous materials have been released.
When it comes to holding LLC members personally liable, no showing of negligence or intent is required under CERCLA. Any LLC member who had the authority to control the operations or decisions involving the disposal of hazardous substances could be held liable for clean-up.
Finding negligence and wrongful acts
Issue: 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. This 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 LLC’s name.
Also, if an LLC member commits a wrongful act that causes injury while acting as an agent or employee of the LLC, it is not just the member’s personal assets that could be targeted by the injury victim. The victim could also go after the LLC’s assets under a theory of vicarious liability (also known as respondeat superior liability) for its agent’s acts.
Protect your personal assets
Do you think an LLC might be the best business structure for your next real estate venture? While an LLC offers many benefits, do not overlook possible personal liability risks. LLC rules vary by state. So, be sure to research your jurisdiction. Consult with your attorney and financial expert to create strategies to protect both your LLC and your personal assets.
For more information, contact Tanya Gierut, at firstname.lastname@example.org, or call her at 312.670.7444. Visit ORBA.com to learn more about our Real Estate Group.