One of the benefits of a limited liability company (LLC) is that owners, called members in an LLC, generally cannot be held personally liable for any debts and legal judgments against the company. Therefore, if the business goes into debt, the creditor cannot take members' personal funds. However, in certain circumstances, LLC members can be held personally liable for the actions of the LLC or its members. In legal terminology, this is called “piercing the corporate veil.”
Under ordinary circumstances, only LLC assets are used to pay off business debts, and the members of the LLC will only lose money they have invested in the LLC. Members of an LLC can also be held liable for any debts of the LLC that they have personally guaranteed. Members can also be held personally liable for court judgments against the LLC if the member has personally and directly injured someone or caused financial loss in the course of business, or has knowingly done something illegal or reckless.
Misuse of Funds
Courts will also sometimes order members to be held personally liable in some other circumstances. One of these is the misuse of company funds, which occurs when a member treats the assets of the LLC as if they were his own. Examples include a member using company funds to buy a house for himself, or a member placing company funds in his own bank account and not keeping adequate records of which funds belonged to the LLC and which funds belonged to himself. Misuse of funds can also include a member paying himself an amount of money that he knows will bankrupt the company.
Liability for Fraud
Courts may hold LLC members personally liable for losses from fraud the members have committed, which includes making fraudulent representations about the business, such as promising the LLC will pay a bill when the member knows this is impossible, or assuring a debtor that the company has financial backing from another source when it does not. Fraud can also include members continuing to operate an LLC while knowing that it is undercapitalized -- knowing that they do not have sufficient funds to cover their obligations.
Failure to Maintain Records
Members of an LLC can also be held personally liable for failing to maintain adequate records. Although LLCs are not required to keep the same kinds of detailed records as corporations, members may still be held liable for for “disregard of formalities.” In an LLC, this behavior may include failure to keep detailed financial records, failure to record minutes of major decisions and failure to follow the terms of the operating agreement.
Read More: Do LLC's Maintain & Record Minutes?
Courts usually require three elements to be present before they will allow the veil to be pierced and a member to be held liable for the financial losses of an LLC. First, the person bringing the lawsuit (the plaintiff) must show that the LLC was controlled and dominated so completely by the member in question that the LLC was a mere instrument of that person and indistinct from her. The plaintiff must then show that a breach of duty occurred -- for example, that the member committed fraud or failed to keep adequate records. The final element is that the control and the breach of duty must have caused injury or loss to the plaintiff.
Since graduating with a degree in biology, Lisa Magloff has worked in many countries. Accordingly, she specializes in writing about science and travel and has written for publications as diverse as the "Snowmass Sun" and "Caterer Middle East." With numerous published books and newspaper and magazine articles to her credit, Magloff has an eclectic knowledge of everything from cooking to nuclear reactor maintenance.