Who Is Liable in an LLC? (LLC Liability Explained)
In a Limited Liability Company (LLC), liability is one of the most significant advantages for its owners. However, it’s crucial to understand how liability works to ensure smooth LLC operations.
With over a decade of practice as a business consultant for limited liability companies across various states, I conducted extensive research on this topic. I consulted with a team of legal experts to provide all the pertinent information you need to understand limited liability in an LLC.
- In an LLC, individuals might be liable if they treat an LLC as a branch of their personal affairs instead of a separate legal entity.
- An LLC generally protects its owners and members from being liable for debts and obligations.
- According to The College of Business, reverse piercing, similar to piercing the corporate veil, can hold the LLC liable for individual debts when the assets are indistinguishable, occurring in approximately 1-2% of cases.
- Drawing from my own experiences as an LLC consultant, I've noticed that most of my clients prefer establishing LLCs because they are guaranteed liability protection in case of a lawsuit.
Who is Liable in an LLC?
No one is liable for any obligations or debt owned by an LLC. A limited liability company is an entity different from its employees and owners. This means that only the company can sue or be sued in case an issue arises.
An LLC's distinct legal entity status ensures a clear separation between the business and its individuals. This delineation means that legal actions, whether initiated by or against the company, exclusively involve the LLC.
However, it's crucial to note exceptions to this general rule. Instances, where negligence, fraudulent activities, or reports of tax evasion come to light, create a deviation from the standard limited liability protection.
In such cases, only the individual accused of the wrongdoing becomes personally liable, emphasizing the importance of maintaining ethical and legal standards within the business framework. The safeguard of limited liability does not absolve individuals from personal responsibility risks in cases involving misconduct or illegal activities.
According to prospect theory, business managers often view risk not as a mere gamble but as a barrier they need to overcome, associating it with a magnitude of losses .
For instance, a prospect offering a 50/50 chance of liability protection can be perceived as more risky than a prospect guaranteeing 50% liability protection, as outlined by behavioral economists Kahneman and Tversky.
This is because business managers may prioritize certainty and view an LLC with a 50/50 chance of liability protection as riskier than one that guarantees a lower percentage, as the uncertainty in the former scenario presents a more significant challenge to be navigated.
What Is Limited Liability?
Limited liability is a legal protection wherein business owners are not personally liable for any business debts, obligations, and liabilities incurred by the LLC; instead, such liability is limited to their investment (ownership) in the company.
LLC owners are individuals or business entities that own interests or shares in an LLC.
The LLC owns the business assets and liabilities and is not transferred to its members.
An LLC protects members' assets from business judgments, including wrongful acts or misconduct committed in their business activities.
However, this protection only applies if the owners comply with state regulations for operating an LLC.
In addition, there may be special rules for LLCs that a single member owns.
At first, navigating the intricate landscape of state regulations became a challenging yet essential aspect of maintaining my business's liability protection shield. I had to stay abreast of and comply with the ever-evolving regulatory landscape, ensuring the protective barrier remained intact.
As an owner of the business, you have limited liability if your company is sued or fails financially.
You can lose only what you invest in it plus any additional debt beyond your investment.
Personal assets such as cars and homes cannot be taken from you to cover business debts, even if they are co-owned by members of your LLC.
"Similar to shareholders in a corporation, LLC members cannot be personally liable for business debts, safeguarding their personal assets such as homes, cars, bank accounts, and investments, with the only potential loss being their initial capital contribution to the LLC."
- Jon Morgan, CEO, Co-Founder & Editor-in-Chief of Venture Smarter
What Protection LLC Offers?
Limited liability is the protection an LLC offers. It means personal assets are protected from the company's debts and liabilities.
The most popular type of personal liability protection for owners is personal limited liability protection, which limits personal asset exposure to business debts and claims against the company.
LLC's debts are usually not personal debts of its owners.
Suppose an owner can be held personally liable for the company's debt. In that case, they are financially responsible for paying off any creditor or claimant who successfully sues them for monetary damages.
However, it's also possible for the LLC to be held liable for an individual's debts (reverse piercing). According to The College of Business, the liability is similar to piercing the corporate veil and accrues when the individual and company's assets are difficult to distinguish . According to their research, reverse piercing occurs in approximately 1-2% of LLC liability cases.
The LLC would be legally obligated to pay creditors and claimants instead of individual members/owners (unless the LLC member agrees otherwise in the operating agreement).
Members of an LLC are not held responsible for the personal actions of other members or employees. This means that personal assets are not at risk if someone is injured during a business activity unless they were personally negligent in some way.
Limited liability partnerships and companies entirely safeguard the responsibility of their owners, which can be a good option for businesses exposed to greater risk.
On the other hand, a One-Person Company may be suitable for a sole proprietor seeking to reduce personal risk. Members cannot be held responsible for LLC debts with their personal property (unless used to secure the debt).
What Protection Can’t an LLC Offer?
An LLC can't offer limited liability protection if the member signed a contract or document under his name personally without representing the company.
Although limited liability companies generally protect their LLC members/owners from liability risks, you can be held personally liable for the following:
- If you promise or personally guarantee by yourself or other people to obtain financing or credit for your business, such as LLC business loans.
- Actions arising from an individual owner's negligence in managing their role within the LLC may not protect the owner from being held personally responsible for a negligent act that results in injury or damages to another person.
- The LLC can be sued in place of its owner when personal injury or property damage occurs because the business failed to maintain adequate insurance coverage for accidents that may occur while conducting business operations.
- You may also be held personally liable if you engage in fraudulent activities, such as making false promises to get investors or deceiving LLC's creditors if your company does not meet the requirements of its business purpose.
- If you need to properly manage your LLC's finances and activities, such as using company funds for personal use or having no personal bank accounts (piercing the corporate veil).
- Suppose any legal issues arise with a lawsuit or other action against the LLC owner personally (as opposed to their interest in the LLC). In that case, an attorney familiar with the state law must be consulted.
- The LLC's owner can also be held personally liable for violating anti-discrimination and other employment regulations after transferring operations to a new employee who violates these rules if the company fails to take action once it is aware of its violation.
Does LLC Include Liability Insurance?
An LLC does not include liability insurance. Members should avail of an insurance policy. Business owners can purchase commercial insurance to protect their organizations against LLC liability claims.
Does a Single-Member LLC Provide Liability Protection?
A single-member LLC provides liability protection to its owner, except when the owner is personally responsible for physical damage or harm to a third party.
Are LLC Owners Liable for Tax Debts?
LLC owners are liable for tax debts, however, the Internal Revenue Service can go after the company's assets to settle tax obligations.
Corporate formalities differ from sole proprietorship and partnerships, so you must seek legal advice if you have questions about the business debts.