What does an LLC protect you from?
You’ve probably heard that a limited liability company can protect you from personal liability, but what exactly does an LLC protect you from?
Both Corporations and Limited Liability Companies offer personal liability protection.
The type of liability that these two business structures offer is to ensure that any incident or loss from your business does not effect your personal assets.
For example, if your Limited Liability Company declares bankruptcy or is sued, your personal assets such as your vehicle, personal bank accounts, and house are safe.
Of course there are always exceptions, but majority of the time, an LLC will protect you from being personally liable.
Types of Liability: Contractual Liability and Tort Liability
There are two main types of liability that you, as an LLC owner, should be familiar with.
Contractual liability is when you agree to do something for someone else.
This includes everything from service contracts and scope of work projects, to bank loans, lines of credit, or credit cards, and real estate or leases.
To avoid putting yourself personally at risk for liability, you must always try to contract in the name of your business entity or as an agent of it.
Sometimes you will need to personally guarantee a loan or commercial lease, but when possible, sign contracts in the name of the business entity.
This helps keep you personally separate from business affairs.
Tort liability on the other hand happens as a result of tortious actions toward another person.
According to Cornell Law, “Tortious behavior is any behavior (other than breach of contract) that may be sued upon as a civil wrong.”
Another term that can fall under tort liability is negligence.
Negligence is “a failure to behave with the level of care that someone of ordinary prudence would have exercised under the same circumstances”, Cornell Law.
If you personally committed the tortious behavior, then you are at risk for losing your personal liability protection.
However, if one of your employees committed the tortious behavior, you are not at risk for losing your personal liability protection, as long as you didn’t know about the behavior and not report it.
Examples of when a Limited Liability Company may not actually protect you personally
While yes, limited liability companies are designed to protect owner(s) and members from being personally liable for the businesses affairs, there are times where you may not be covered.
Knowing these instances can help you avoid them from happening within your own LLC.
Here are some examples of how you may become personally liable for your LLC:
- Owner(s) or members participate in tortious activity.
- Signing personal guarantees for bank loans, real estate, lines of credit, credit cards, or other liabilities.
- Using a personal check for the LLC and the personal check bounces.
- Mixing personal and business expenses or using one bank account. A court of law may rule that there was no separation between personal and business assets, therefore you become personally liable for the LLC. This is called “piercing the corporate veil.”
- Not meeting fiduciary duties: duty of loyalty, duty of care
- The LLC has not paid certain federal or state tax liabilities
- Don’t sign any personal guarantees – a personal guarantee makes you personally liable should your LLC not meet the requirements of the personal guarantee. For example, if you signed a personal guarantee on a loan for your LLC, you are liable for that loan should your LLC default.
- Don’t partake in fraudulent activities – for example, if your LLC is having cash troubles or insufficient funds and you knowingly take out a loan, this is considered fraud and you will be personally liable for the loan. Furthermore, if the other LLC members are committing fraud, and you know about it but do not report, it you will also be personally liable.
- Don’t “Pierce the Corporate Veil” – don’t act in a way that a court might rule that you and the LLC are one in the same.
- Keep personal and LLC bank account separate
- Make sure your LLC has the correct insurance plan(s)
- Make sure your LLC is formed correctly
If you are honest, careful and follow the rules, you most likely will not be personally liable for anything that goes wrong with your LLC.
However, as you can see, there is still some risk involved and you are never 100% liability free when owning a business.
Understanding the risks and how to avoid them in key to protecting yourself and your business.
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