It is not uncommon for an owner to have a couple of sleepless nights after a lender or vendor files suit against the business. Whether that lawsuit can reach you personally depends mostly on how the company is set up and on what you signed. For owners who run their business as a limited liability company, the starting point is reassuring. Generally, an LLC’s debts are paid from the company assets and not from an owner’s assets. An LLC is a separate legal entity, meaning the company owns the assets, incurs the debts and is liable for its actions. In other words, an LLC is supposed to create a “wall” between the company and its owners, so that if the company gets into trouble, only the company’s assets are at risk.
That wall is the reason most people form an LLC. The main purpose of forming a company is to keep your personal assets and liabilities separated from your business. This is a concept called “limited liability“. LLCs combine features of partnerships and corporations, and like corporations, but unlike partnerships, their members usually are not personally liable for judgments against the business. In most cases that protection covers your house, cars, personal bank accounts and private investments.
So what happens if the creditor wins? If the court rules against the LLC, its bank accounts and property can be taken to satisfy the judgment, meaning cash, inventory, equipment, real estate, and the like. The business, and its funds and assets, are liable. LLC members are generally not liable for acts of other LLC members, either. Even though your business partner’s bad decisions may have brought about the lawsuit, as long as you did not personally guarantee the debt, the debtor in the lawsuit is your business, and not you. In other words, the company’s debt is its debt, not your debt. The LLC may not, however, shield you from liability if you personally do something wrong. An owner or employee who commits a wrongful act can be personally liable for it, while a co-owner who had no part in it would not be.
The Protection an LLC Offers Is Not Perfect
However, that does not mean you are totally out of danger. The protection an LLC offers is not perfect, and there are three main ways a creditor can get past it to reach an owner.
The first is a personal guarantee. Even with an LLC, you can still be personally liable if your LLC’s loan has a personal guarantee. This is a separate agreement between the lender and the LLC’s owner. When you sign a personal guarantee, you agree to take personal responsibility for repayment of the loan. This means that if your business can’t pay off the loan, the lender can pursue you personally for the debt. Banks and other lenders often ask an LLC’s owners to sign a personal guarantee before extending the business a small business loan. In signing the guarantee, an owner may guarantee an LLC’s debt, personally putting up their home or other property as collateral. If you signed one, the creditor can come after you as well as the company.
The second is a breach of duty. Under Florida Statutes Section 605.04093, LLC managers or members can be personally liable when they fail to perform their duties. Note that the statute says manager or member. This means that, a member who’s not a manager can be held personally liable. The section is narrow, though: a manager or member will only be held personally responsible for breaching his or her duties if the breach of duty constitutes a violation of a criminal law; involves a transaction from which the manager or member receives an improper benefit; is an improper distribution; demonstrates conscious disregard of the best interests of the LLC or willful misconduct; or is reckless, malicious or in bad faith. In case this seems contrary to the main purpose of forming an LLC, remember that to limit liability, everyone has to do their job.
Piercing the Corporate Veil
The third is piercing the corporate veil, which can happen even if you never signed a guarantee. Piercing the corporate veil refers to a legal doctrine whereby a court can look past a company’s separate identity and hold the owner personally liable for the company’s debts or obligations. Courts generally lean toward upholding the LLC’s protection. Typically, a court is not going to pierce the corporate veil and hold a small business owner personally liable unless there has been fraud or other wrongful conduct, or unless it finds no true separation between the LLC and its owners, meaning the company was not acting as an independent entity, but was merely an alter ego of the shareholders or owners. In deciding, courts look at whether the LLC engaged in fraud and to what extent, whether it ignored formalities such as holding annual meetings and filing required documents, and whether the owner “commingled” corporate and personal assets.
The rules for piercing the corporate veil in Florida are more strict than in other jurisdictions. The revised Florida LLC Act protects members who do not strictly follow company formalities such as holding annual meetings and filing reports. So, piercing the veil is something that is only done in very unusual cases. Take a Florida case called Segal v. Forastero, Inc. The trial court concluded an individual shareholder was liable for a breach of contract judgment against a real estate limited liability company, and so pierced the corporate veil. The Florida 3rd District Court of Appeal overturned the trial court’s decision, holding that none of the three requirements to establish that the company was the defendant’s alter ego had been satisfied and that all three requirements must be satisfied in order for the veil to be pierced. The message for creditors was that you can’t just tack on the members to the judgment.
None of this means an LLC is a license to walk away from obligations. It’s not OK if the entity is used to defraud others. But that doesn’t mean it’s not OK for a company or other business entity to do what it’s supposed to do and limit liability. In other words, you cannot abuse your LLC status, but if you do, you can be personally liable. The details of your case, including what you signed and how the business has been run, will decide where you stand. If a creditor has sued your business, you might want to consider consulting with an attorney before you do anything else.
