Key Takeaways

  • An LLC offers limited liability protection, shielding personal assets from business debts and lawsuits.
  • This protection can be compromised by personal wrongdoing, mixing personal and business finances, or not following proper business formalities.
  • Creditors may still access LLC assets or a member’s ownership interest through legal means like charging orders.
  • Asset protection is enhanced by maintaining separation between the LLC and its members, using operating agreements, and maintaining adequate capital.
  • Some risks are not covered by LLC status, such as personal liability for personal actions or improper conduct.

LLC legal protection includes the personal liability protection offered by a limited liability company, a type of business entity that is legally separate from its owner or owners (known as members). Limited liability protection means that your personal assets cannot be seized to pay for debts and financial obligations of the LLC. An LLC operates as a pass-through tax entity, which means the members report profits and losses on their individual tax returns as they would for a partnership or sole proprietorship. 

LLC Liability Protection

When creating a new business, it's important to consider the liability risk you take on and avoid as an LLC owner. While all LLCs offer their owners limited liability, the extent of this protection varies by state. In general, though, LLC legal protection covers:

  • Personal liability for the debts of the business
  • Personal liability for the actions of other LLC members or employees
  • Personal liability for your own actions associated with the LLC
  • LLC liability for members' debts and financial obligations

Key Limits to LLC Protection

While LLCs provide strong protection, this shield is not absolute. Courts may "pierce the corporate veil" and hold members personally liable if:

  • The LLC was undercapitalized at formation.
  • The LLC fails to observe corporate formalities.
  • There’s commingling of personal and business funds.
  • Fraud or misrepresentation occurs.

In these situations, members may lose the personal liability protection typically offered by the LLC.

Personal Liability for LLC Debts

In most states, members are not responsible for the debts of an LLC unless they provide a personal guarantee for these debts. That means business creditors can go after the accounts and property of the business to pay these debts, but the members' individual assets are protected. Some creditors may ask for a personal loan guarantee, which means that you will be personally responsible for covering any debts left unpaid by the business.

Personal Guarantees and Business Loans

Lenders often require personal guarantees, especially from new or small LLCs without substantial assets. If you sign a personal guarantee, you become personally liable for the debt, regardless of the LLC's structure. Always review loan terms carefully and explore options that avoid personal guarantees where possible.

Personal Liability for Members' Actions and Debts

The protection afforded by your LLC extends to wrongdoings and unpaid debts of other members and employees. If the business is found responsible for these actions, the LLC accounts and assets can be seized, but your personal assets are safe. The member who is involved in the illegal or negligent actions may be held personally responsible, however. For example, if an employee kills a pedestrian while making a delivery for the LLC and is found to be negligent in that accident, the LLC's assets and those of the employee in question can be seized to pay the legal judgment. Your personal assets cannot be touched.

Liability for Illegal Acts by Other Members

An LLC member is generally not liable for wrongful acts committed by others. However, if you knowingly allow or ignore illegal conduct, such as theft or fraud by a partner, courts may find you partially liable. The more involved you are in management decisions, the greater the risk of exposure.

Liability for Your Personal Actions

If you commit wrongdoing in the course of operating your LLC, you will be personally responsible for these actions. This may include instances in which:

  • You personally injure someone due to negligence.
  • You do not deposit taxes taken out of employee wages.
  • You intentionally commit fraud or another legal or reckless action that harms the LLC or another person or entity.
  • You mix your personal affairs and accounts with those of the LLC.

The last item above is the most important. If personal and business funds are mixed, the court might decide that the LLC does not exist and therefore, that all members are personally liable for its debts and obligations. Prevent this occurrence by:

  • Truthfully and fairly representing finances and material facts to customers, creditors, and vendors
  • Investing enough money in the business so it can cover debts and obligations
  • Registering for an employer ID number (EIN) with the IRS and establishing a business checking account for the LLC
  • Creating a formal operating agreement, which details the administration and operation of the LLC

Consider the example above. If you knew your employee was driving drunk when he killed the pedestrian but allowed him to operate a business vehicle, you could be considered personally liable and your assets can be seized to pay damages.

Activities That Void LLC Protection

Certain behaviors can strip you of LLC protection, including:

  • Personally signing contracts in your name rather than the LLC’s name.
  • Using the LLC for personal expenses or vice versa.
  • Failing to keep accurate financial records.
  • Not filing required annual reports or fees.

Proper documentation and clear role separation are essential to maintaining limited liability.

LLC Liability for Member Debts

Although the LLC's assets cannot be seized to cover the personal debts of members, creditors can take legal steps to satisfy these debts depending on the state. These may include:

  • Getting a charging order from the court demanding that the LLC pay the outstanding debts
  • Foreclosing on the LLC ownership interest of the member in question
  • Getting a court order for dissolution of the business

If the ownership interest is foreclosed on, the creditor becomes the owner of that member's financial rights. If the LLC is dissolved, it will have to sell its assets and cease business operations. Most states require the creditor to start by obtaining a charging order.

Understanding Charging Orders

A charging order is a legal remedy that allows a creditor to receive distributions owed to a debtor-member. However, it does not give the creditor control over LLC operations. In some cases, if a creditor forecloses on a member’s interest, they may acquire financial rights but not management rights. States like Delaware and Nevada offer stronger charging order protection for LLC members.

Frequently Asked Questions

  • How does an LLC protect you from personal liability?
    An LLC shields your personal assets from business debts and lawsuits, limiting financial exposure to what you've invested in the company.
  • Can I be held personally liable for business debts if I didn’t sign a guarantee?
    Usually not. However, personal liability can arise if you signed a personal guarantee, committed fraud, or mixed personal and business assets.
  • What is "piercing the corporate veil"?
    It’s a legal action where courts disregard the LLC's separate legal status, making members personally liable for the company’s obligations due to misconduct or mismanagement.
  • Does LLC protection cover employee misconduct?
    The LLC itself can be liable for employee actions, but members are protected unless they were complicit or negligent in supervision.
  • How can I ensure my LLC protection remains intact?
    Keep personal and business finances separate, comply with state requirements, maintain proper records, and use written agreements.

If you need help with understanding the legal protection offered by a limited liability company, you can post your legalneed on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.