Some small businesses prefer a limited liability legal structure because it makes it extremely difficult to pin debt on members, or owners. Nevertheless, actions by an LLC could compromise the limited liability of the company, and individual members may lose their limited liability by making improper decisions. To steer clear of legal trouble, members must diligently follow the rules governing LLCs.
In the LLC structure, members are shielded from the company's debts and most lawsuits, similar to the shareholders of a corporation. Creditors and litigators must go after the business's assets rather than those of the owner or owners. The law has one major exception: LLC members may be liable for employee claims, such as work accidents.
Because LLCs bear the burden of most debts and litigation, members face less personal investment risk. For example, if an LLC goes out of business, members are only liable for the amount of money they invested in the company. If an LLC goes bankrupt and cannot repay its debt, members do not need to fear losing their personal property, such cars or homes.
Members of an LLC lose limited liability if they use the company for fraud, such as money laundering, or mix company and personal business, according to Expert Law. Also, individual members can lose their limited liability if they personally guarantee a debt of the LLC or deliberately try to harm the LLC.
As of 2010, at least three court cases, including "In re: Ashley Albright," have ruled that single-member LLCs have no asset protection, according to Arizona attorney Richard Keyt. These cases ruled that single-member LLCs share the same identity as the owner. If a single member tries to protect the LLC by going to bankruptcy court, the bankruptcy court trustee can liquidate all of the company's assets to pay back creditors — effectively dissolving the company.
Read More: Going From Multi Member LLC to Single Member LLC
Owners of an LLC should create an operating agreement, which lists the management structure of the company, to help give credence to the claim that the business is a separate entity, according to Nolo. If you are a single-member LLC, never file bankruptcy and consider adding another member. Make sure, however, that the new member pays for his share in the company or the courts may see it as a fraudulent way to protect your personal and business assets.
Russell Huebsch has written freelance articles covering a range of topics from basketball to politics in print and online publications. He graduated from Baylor University in 2009 with a Bachelor of Arts degree in political science.