Key Takeaways:

  • LLC members can sue each other under specific circumstances, such as breaches of fiduciary duty, fraud, or violation of an operating agreement.
  • A well-drafted operating agreement is crucial in determining how and when disputes can be litigated.
  • State laws may override an LLC’s operating agreement, affecting members’ rights to sue each other.
  • Common reasons for lawsuits include financial mismanagement, misuse of company assets, and breaches of fiduciary duties.
  • The corporate veil protects members from personal liability, but it can be pierced if fraud or misconduct occurs.
  • Alternative dispute resolution (ADR) methods such as mediation and arbitration can help resolve disputes without litigation.
  • Seeking legal counsel before initiating litigation can help ensure compliance with LLC agreements and state laws.

Can LLC members sue each other? This is an important question to understand when choosing to enter into a business relationship with other individuals. The short answer is, yes, but there are some rules in place that govern exactly how and when this can happen.

What Is an LLC?

An LLC (limited liability company) is a business structure that has become increasingly popular in the United States business realm over the past several years. LLCs offer a flexible company structure with different management options, plus some legal and financial protection for members.

The owners of an LLC are called its members. These are similar to the shareholders or investors of a corporation. Even though the members of an LLC are fairly well-protected from creditors and liability issues, they do have the right to take legal action against one another for wrongdoing.

When Can LLC Members Sue Each Other?

When first forming an LLC, the members should draft an operating agreement. Here they should outline exactly how any members can take legal action against one another. A well-detailed LLC operating agreement will govern most disputes within the business and should help to keep such disputes from damaging the business.

If the operating agreement states that members can be held liable to one another for wrongdoing, then one member is able to bring suit against another. However, if it states that the members are not liable to each other, usually no legal action can be taken. If the members of an LLC choose to include such a provision in their operating agreement, they should be very sure that such legal action will never be necessary.

Some states have LLC regulations in place that can either trump an operating agreement or take the place of one if none exists. State regulations usually support the rights of LLC members to sue one another for good reason.

If an operating agreement doesn't explicitly state how and when legal action can take place between members and the state in which your LLC does business doesn't have any regulations on the matter, you can only bring suit if:

  • You can prove that you have suffered harm apart from the business.
  • You can prove that you have suffered harm apart from the other members.

These can be tough stipulations to prove, so it's better to have things clearly laid out in an operating agreement as soon as the business is up and running.

Regardless of any state and operating agreement requirements, taking suit against another, especially someone you do business with, is a big deal. The first thing you should do when considering legal action is consult a professional business attorney.

Common Reasons for LLC Members to Sue Each Other

There are several common scenarios in which LLC members may initiate legal action against one another. These include:

  1. Breach of Fiduciary Duty – If a member acts in bad faith, engages in self-dealing, or fails to act in the best interests of the LLC, they may be sued.
  2. Misappropriation of Business Assets – When a member improperly uses company funds or assets for personal gain, the other members may have grounds for a lawsuit.
  3. Financial Mismanagement – If a member’s reckless financial decisions harm the LLC or cause financial losses, litigation may be an option.
  4. Contract Violations – Breaching the terms of the operating agreement, such as failing to contribute capital or interfering with business operations, may lead to lawsuits.
  5. Fraudulent Activities – If a member intentionally deceives other members regarding the company’s financial health or business dealings, they may be held legally accountable.
  6. Deadlock Between Members – If an LLC is member-managed and a significant disagreement prevents business operations, litigation may be necessary to resolve the issue.

How Does the Corporate Veil Come Into Play?

The corporate veil refers to the liability protection afforded to the members of an LLC. This means that the company is a legal entity itself and, therefore, it can:

  • Sue and be sued
  • Own property
  • Take out loans
  • Be held liable

If a member of an LLC is injured somehow by the company, they can take suit against the LLC itself, rather than one or all of its members.

Exceptions to the Corporate Veil Protection

While the corporate veil generally shields LLC members from personal liability, courts may allow it to be pierced under certain conditions, including:

  • Commingling of Personal and Business Finances – If members fail to separate personal and company finances, creditors or other members may hold them personally liable.
  • Undercapitalization – If an LLC is intentionally underfunded and unable to meet its obligations, courts may allow members to be sued individually.
  • Fraudulent or Illegal Conduct – Engaging in fraudulent business practices or illegal activities may lead to personal liability.
  • Failure to Follow Formalities – While LLCs are not required to follow corporate formalities like annual meetings, failing to maintain essential records and agreements may weaken the corporate veil.

When Are Members Held Liable?

Sometimes, members can be liable for their decisions or actions as a part of the LLC. This is when the corporate veil is pierced. Some common ways that the corporate veil can be pierced include:

  • Failure to keep personal and company assets separate
  • Failure to make enough money to keep the LLC running and pay debts
  • Failure to follow rules and regulations for business formation properly
  • Fraud or any illegal business activities
  • If a member personally co-signed on a loan for the business

Alternative Dispute Resolution for LLC Member Disputes

Litigation can be costly and time-consuming. Many LLCs include alternative dispute resolution (ADR) clauses in their operating agreements to resolve disputes more efficiently. ADR methods include:

  • Mediation – A neutral third party helps the members reach a mutually agreeable resolution.
  • Arbitration – A private arbitrator hears both sides and makes a binding decision, which can be quicker and more cost-effective than court proceedings.
  • Negotiation – Direct discussions between members, often with legal counsel, may resolve disputes without formal proceedings.

Using ADR can help preserve business relationships and minimize disruptions to the LLC’s operations.

Fiduciary Duties

The fiduciary duties owed to a business by its members refer to their expected loyalty to and care for the business. When entering into a business relationship with another, it is vital to have trust that all members of the LLC will act in the best interest of the company and not in their own best interest.

Member-managed LLCs require different duties of their managing members than their non-managing members. Such duties and responsibilities should be clearly outlined in the LLC's operating agreement.

Best Practices to Prevent LLC Member Disputes

To reduce the likelihood of disputes escalating into lawsuits, LLC members should implement the following best practices:

  1. Clearly Define Member Roles – The operating agreement should specify the responsibilities of each member to prevent conflicts over decision-making.
  2. Implement Financial Transparency – Regular financial disclosures and audits can prevent disputes over financial mismanagement.
  3. Use Non-Compete and Non-Disclosure Agreements – Protecting business interests by preventing members from engaging in competing businesses can reduce conflicts.
  4. Plan for Dispute Resolution – Including mediation or arbitration clauses in the operating agreement can help resolve disputes without resorting to litigation.
  5. Document All Agreements in Writing – Verbal agreements often lead to misunderstandings. Keeping detailed records of business decisions can provide clarity and legal protection.

Frequently Asked Questions:

1. Can two partners in an LLC sue each other?

Yes, LLC members can sue each other if a legal dispute arises, such as a breach of fiduciary duty, fraud, financial mismanagement, or violations of the operating agreement.

2. What is the most common reason for LLC disputes?

The most common reasons include financial mismanagement, misuse of company assets, and disagreements over business decisions or ownership stakes.

3. Can an LLC member be personally liable for company debts?

Generally, no. However, if a member engages in fraudulent activities, commingles personal and business funds, or fails to properly capitalize the LLC, they may be held personally liable.

4. What should be included in an LLC’s operating agreement to prevent disputes?

A strong operating agreement should clearly outline financial contributions, decision-making authority, dispute resolution processes, and procedures for removing or replacing members.

5. Should LLC members use mediation or arbitration before suing?

Yes, mediation or arbitration can be more cost-effective and less disruptive than litigation. Many LLC operating agreements require these methods before pursuing legal action.

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