Can a LLC Be Sued?: Everything You Need to Know
Generally, an owner of an LLC is not legally responsible for the actions of the business. However, there are certain situations where an owner can be sued.3 min read
Updated June 25, 2020:
Can a LLC be sued? Generally, an owner of an LLC is not legally responsible for the actions of the business. Therefore, an owner cannot be sued for the obligations of the company. However, there are certain situations where an LLC owner can personally be sued for the actions of an LLC.
Can an LLC Be Sued?
A limited liability company (LLC) is a fairly modern business entity that is governed by the laws of each state. In the 1970s, Florida and Wyoming became the first states to recognize this type of business structure. By 2010, LLCs became recognized in all 50 states and in the District of Columbia, each with its own state statutes regulating the creation, management, and termination surrounding LLCs. Similar to a corporation, an LLC is individual legal entity that has the capability to sue or to be sued.
Separate legal entity: According to state laws, LLCs are considered independent entities that are legally separate from their managers and owners, who also are referred to as “members.” In the court system, LLCs and corporations basically receive the same treatment. This helps to legally protect officers, directors, and shareholders, and to stimulate commerce. LLCs can build their credit with lenders by entering into leases and other financially-based contracts.
Asset protection: One significant benefit of establishing an LLC is that it protects members' personal assets. This means that owners are not accountable for the liabilities and debts of the LLC. To specify, if an LLC is sued and owes a financial judgment, the plaintiff generally cannot pursue the members' personal assets or bank accounts. Likewise, the same rules apply for credit lenders who financially back LLCs.
In the legal system, this liability protection is referred to as the “corporate veil.” Piercing the corporate veil occurs when corporate directors and officers are held liable for a corporation‘s actions. There are cases in which the courts will use the principal of “piercing the corporate veil” to go after the personal assets of LLC members. This typically occurs when the members have been involved in fraudulent activities.
Laws regarding this doctrine vary from state to state, but there are some common factors that exist. When determining if the corporate veil should be pierced, the courts will examine the following:
- Misuse of company funds: One or more members misuse funds by using company money for personal use or co-mingling company and personal bank accounts
- Capitalization of the LLC: Companies with large debts and minimal capital may raise a red flag in some cases
- If fraud was involved: One or more owners used the LLC to participate in fraudulent activity
Courts typically make this decision on a case by case basis, using a fact-based examination. Piercing the corporate veil is typically more effective with small, close companies and privately-held entities. These are corporations that have limited assets and a small number of shareholders.
Service professionals: There are many state laws that limit the ability of service professionals to create an LLC. These professionals may include lawyers, architects, doctors, and accountants. Owners of these business types may consider forming an LLC in order to reduce risk and limit liability. However, many states prohibit service professionals from starting an LLC, instead requiring them to form a professional limited liability company (PLLC). PLLCs often have different rules and regulations than LLCs.
Additionally, some states permit professionals to form PLLCs or LLCs, but restrict the entity from limiting their liability for professional malpractice. As a service provider, it's important to understand the legal rules and regulations in the state where your business entity is located.
Can an Owner of an LLC Be Sued Personally?
A major concern when starting a business is being able to protect the owner's personal assets. Many business owners are worried that if their business makes a mistake, they'll lose their business, home, and other assets. A sole proprietorship offers no protection to the owner. For example, if the owner lacks the funds to settle a lawsuit, then the owner must pay out the difference from their own personal assets.
An LLC provides protection to the owner's assets and doesn't make them liable to the business's creditors. Also, an owner is usually not able to be sued for actions taken by the business. Of course, there are situations where personal liability protection has been lost.
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