You formed an LLC for a reason. Without the LLC, any debt or liability goes directly to the owner, so a debt collector can get a judgment against a business’s owner and go after the owner’s house, car or savings. The separation the LLC creates means that if the business is liable for a debt, it’s the business’s assets that are on the line, not the owner’s. But a bank or equipment rental company looking at a young LLC without much credit and without much income might ask you to sign a “personal guarantee” (PG) so that they will have something to enforce if the company doesn’t pay them. The reason they ask for personal liability is a personal guarantee protects them if the LLC defaults. Without the personal guarantee they are at the mercy of limited liability. This means that your personal assets could now be in jeopardy. Is signing a PG a total loss of your limited liability, or is there room to argue that a PG doesn’t actually pierce your liability shields?
The Shield for the Debt You Signed For
Not entirely, but it does strip away the shield for the debt you signed for. Say your trucking company leases a tractor-trailer and the leasing company makes you sign a guarantee. So, if your LLC does not pay the tractor-trailer lease debt, the leasing company can go after you personally and make you pay. Your company’s limited liability doesn’t change that. In effect, instead of separating the business and its owners, a personal guarantee makes the members liable for the LLC’s debt. If the LLC does pay the debt, then you don’t have to pay it. The personal guarantee is the second-string quarterback: she’s not going to get in on the field unless the first-string quarterback gets injured or decides not to show up.
Keep in mind, though, that this changes things only for that one debt. The LLC’s owner will have guaranteed only that one loan or contract with the leasing company. The LLC owner still keeps all the other advantages and protections the LLC offers. All other business debts are still the LLC’s sole responsibility, and your personal assets are still separate and (hopefully) protected.
Jointly and Severally Liable
It gets worse if you didn’t sign alone. When you and your two co-members all sign the guarantee, you will most likely be jointly and severally liable, which means the bank can demand the total amount due from any one of you. So the bank could choose to pursue you alone, your partners alone, or any combination of the three. If you have more personal assets, or are simply the easiest person to collect from, that person is you. In theory, each of you should only have to pay one-third of the total amount, but if one of you can’t pay, the others will have to come up with the remaining balance. You may still have a right to demand that your partners pay their fair share, but if they refuse you may need to sue them, and if they don’t have the money, they cannot pay you their fair share and you’re stuck eating the whole loaf. Make sure you (and all LLC members) are familiar with the fine print and read the legal document thoroughly. The last thing you need is to land yourself in a financial lurch because you didn’t understand what you signed.
Pierce the Veil
At this point, the “hopefully” in the last section becomes critical. What happens if your LLC’s limited liability doesn’t hold? Maybe your LLC was never capitalized properly or maybe your LLC’s formation documents are a bit wobbly. That makes the LLC look flimsy, and a court might decide to pursue you personally after all. Even if you never sign a guarantee, a creditor can ask a court to pierce the veil, the veil being your limited liability. If you’re using your LLC as a “shell,” i.e., you’re ignoring formalities, commingling your personal assets with those of the company, and using the LLC to “run roughshod over creditors”, the court can make you personally responsible for your LLC’s obligations, e.g., go after your house for your LLC’s unpaid debts. The court will ask whether it is fair to hold you personally accountable, and whether the LLC was run as a fully separate entity or was just your alter ego. If you haven’t treated your LLC like a real entity (holding meetings, voting on major company decisions, keeping separate books and accounts for the LLC, signing agreements in the name of your LLC), then you probably haven’t been running your LLC properly.
The first place a court and your creditors will look is the paperwork: whether the LLC was properly formed, whether it has an operating agreement, and whether its dealings were written down rather than done on a handshake. Your LLC exists on paper, so you should also have paperwork that shows your LLC being run like a real entity that can enter contracts. Skip that, and a court can decide the LLC effectively doesn’t exist.
Then there’s money. You can’t mingle personal transactions with the LLC’s transactions, or you’re merging the two - that’s commingling. So, when you withdraw money to pay a purely personal expense, that’s commingling. A family dinner. A pizza party. A movie theater trip for the whole family. Anything personal in nature. When the finances of the business and finances of the individual become commingled, the court can say “Fine, then, forgo the protection of limited liability.” If you own more than one company, the same goes for paying one company’s bills out of another’s account. You can lend money to the company, and the company can pay you as an owner or an employee, but put it in writing.
People often save time and money early on by putting only minimum money into their business, hoping that they can fund it once it starts to grow. But if your business never had the capital it needed to have a chance at success, courts are less likely to allow you to hide behind it. If it is clear from the get-go that the LLC is not well funded, the court may hold its owners liable for its debt. Creating an LLC with nothing in it turns your LLC into a construct rather than an entity. If you work in a high-risk field such as construction or medical services, you need insurance for those risks as well. This, combined with the lack of paperwork and commingling, makes a court more likely to disregard your liability protection.
You also have to act like a company. You don’t get to use your own name and then hide behind the LLC. The LLC is a separate legal entity, so when you do business with it, it should be clear and unambiguous that you are doing so. If people reasonably believe they are dealing with you personally, a court can make you personally liable. Put “LLC” after the company name on every contract, every invoice and, for god sake, on the letterhead.
The protection can fail in the other direction too. In what is called reverse piercing, when a co-owner, usually the one in control, uses the business’s name to run up personal debt through fraud or other wrongdoing, a court can make the business liable for it. In other words, your co-owner’s debts become the business’s debts. If you wouldn’t trust someone to watch your house or borrow your money, think hard before going into business with them.
You wouldn’t buy a plant and expect it to survive without watering it. You also wouldn’t lend it to someone who is a proven zombie plant killer. Getting the LLC’s limited liability is really a matter of common sense: Do your paperwork, keep your financial transactions separate, treat your LLC like a separate entity, and don’t associate with co-owners who are liars and cheaters.
So, does signing a personal guarantee erase your liability shield? The answer is that a personal guarantee is a limited loss of your liability shield. It makes you personally answerable for the debt you guaranteed, and possibly for all of it if your partners signed too. Does signing a personal guarantee make the LLC totally worthless, exposing you as co-owners to personal liability? No. But whether your liability protection holds depends on your paperwork and your behavior. Bottom line: Keep it separate. From the paperwork to the money in the bank account, make the LLC its own entity. And if your company is already struggling, start by sorting out which debts carry your personal signature, because those are the ones that can follow you home.
