America is the land of the free, where customers or interested parties can sue your business and pursue it for substantial amounts. Consider protecting your assets with LLC liability protection if you plan on owning a business. This blog post dives into what an LLC is, how it offers limited liability protection to business owners, the various types of liability protection an LLC provides, as well as the potential limitations and risks.
What Is LLC Liability Protection?
A limited liability company (LLC) is a business entity legally distinct from its owners (members). The LLC provides limited liability protection to the members, which ensures that creditors cannot seize the owners’ personal assets to pay for the LLC’s debts and other financial obligations. This protection mechanism contrasts with a sole proprietorship or partnership, where the owners bear personal liability for the business’s debts and could lose their personal property if the business fails or is sued.
By creating a distinction between the business and personal affairs of the owners, an LLC limits liability to the assets within the LLC. The LLC is treated as a distinct legal entity with its assets, liabilities, income, and expenses. The owners are not responsible for the LLC’s debts unless they personally guarantee or promise to pay them. If the LLC cannot pay its creditors, creditors can only go after the LLC’s assets and not the owners’.
Let’s say you own an LLC that runs a bakery. You invest $10,000 in the business and purchase equipment and supplies. One day, a customer slips and falls on your premises, suing your LLC for $100,000 in damages. If your LLC cannot settle the lawsuit because of insufficient funds or insurance, the customer can only collect the amount from the LLC’s assets, such as the equipment and supplies. The customer cannot touch your personal assets, such as your bank account, car, or home. Your risk is limited to the $10,000 invested in the business.
Types of Liability Protection an LLC Offers
LLCs provide liability protection to owners based on the type and origin of the liability. Let’s take a look at the kinds of liability protection an LLC has to offer:
1. Protection from Business Debts
Creditors such as suppliers, lenders, or landlords pursuing an LLC’s assets cannot typically go after the owners’ assets. This restriction aims to keep the members’ personal properties (homes, cars, or bank accounts) from being seized or garnished by creditors.
LLC protection from business debts proves valuable in situations like bankruptcy, foreclosure, or lawsuits. If an LLC defaults on a bank loan, for example, the bank can only pursue the LLC’s assets and not the members’ assets. Similarly, if a customer sues an LLC for a defective product or service, the customer can only claim damages from the LLC’s assets and not the members’.
For example, in the case of Dover Phila Heating & Cooling, Inc. v. SJS Restaurants, Ltd., as per Ohio law, the court acknowledged the limited liability of LLC members and concluded that there was no evidence to establish the liability of an LLC member for the debts incurred by the LLC.
2. Individual Member Liability
Personal liability refers to the liability that personal assets may be responsible for, while individual member liability means the member’s responsibility for the liabilities of the LLC. Although members are generally shielded from personal liability for LLC obligations, each member’s original investment and ownership value in the company can be used to pay for LLC debts and obligations.
If a member participates in or authorizes illegal or wrongful acts by the LLC or another member, they may be personally liable for any resultant damages or penalties.
Members need to act carefully and diligently by following the LLC’s operating agreement and any applicable laws and regulations. Adequate business insurance can also cover potential liabilities.
3. Protection from Lawsuits
An LLC functions as a distinct legal entity that can initiate or be the target of lawsuits. If someone sues the LLC for negligence, breach of contract, or infringement, any payment issued as the result of a judgment or settlement against the LLC should come from the LLC’s assets rather than the personal assets of its owners.
This protection is especially valuable in high-risk industries or professions where litigation is common. For example, if an LLC provides professional services, such as accounting, consulting, or engineering, and makes a mistake that harms a client, the client can sue the LLC for malpractice but not its owners personally.
However, protection is not absolute. Owners may still face personal liability for lawsuits against their LLC in situations such as if an owner personally causes harm while working for their LLC, personally guarantees a contract or debt, fails to pay taxes or fees owed by the LLC, or engages in fraudulent activity or other illegal or wrongful acts involving their LLC.
Comply with all legal and ethical standards and obligations when operating an LLC and obtain appropriate liability insurance coverage for potential lawsuits against the LLC, such as general, professional, or product liability insurance.
4. Contractual Liability Protection
LLCs offer contractual liability protection, which is liability arising from a contract or agreement between parties. Contracts can be written or oral and can involve sales, leases, services, partnerships, or loans. An LLC limits personal liability for contracts and agreements, so if an LLC breaches a contract or fails to fulfill its obligations, the other party can only sue the LLC, and usually not the owners personally.
This protection is helpful in disputes or defaults involving contracts or agreements. However, it is not absolute and protection can be increased with an indemnity clause or decreased by signing a contract in a personal capacity or agreeing to a hold harmless agreement. It is important to read and understand all contracts, use clear language, and consult with a business attorney if necessary.
5. Financial Liability Limitations
Financial liability arises from managing your finances, such as borrowing, investing, paying taxes, or making donations. Financial liability can significantly impact a business’s profitability and sustainability. If you manage your finances through your LLC, you can limit your financial liability by using insurance coverage, financial limits, and risk management.
Insurance is a common approach used to transfer the risk of loss from one party to another in exchange for a premium. Financial limits are contractual provisions that set a maximum amount that one party can claim from another in case of a breach or default. Risk management involves identifying, analyzing, evaluating, and controlling risks that may affect a business’s objectives or operations.
6. Employee Liability Protection
Employers are legally responsible for their employee’s actions or omissions, which means they may be held liable for any harm or damage caused to a third party. This employee liability can result in financial losses, legal disputes, and reputational damage.
LLC can offer protection through workers’ compensation insurance, which covers employees’ work-related injuries or illnesses; and employment practices liability insurance (EPLI), which covers legal costs and damages from lawsuits by employees. Employers can also reduce liability exposure by ensuring compliance with relevant employment laws and regulations.
Understanding Piercing the Corporate Veil
The concept of “piercing the corporate veil” refers to a situation in which a court disregards the liability protection of an LLC and holds its owners personally liable for the LLC’s debts or obligations. Piercing the corporate veil is a rare and severe measure that courts only use in exceptional cases where owners have abused or misused the LLC structure to commit fraud, evade taxes, or harm others.
Factors that courts may consider include failure to follow the regulations, commingling personal and business assets, undercapitalization, and using the LLC for purposes indistinguishable from personal interests.
To maintain liability protection, follow the rules and regulations, keep personal and business finances separate, provide adequate capital and cash flow, and maintain a clear separation between yourself and your LLC.
LLC Formation Made Easy With doola
An LLC offers numerous benefits, including limited liability protection, tax flexibility, and management freedom. By creating legal separation between personal and business property, you can insulate yourself from financial and legal risks. However, it also poses challenges, like complying with legal requirements and maintaining the LLC structure.
doola, a one-stop-shop for business founders can help you form an LLC online in minutes. With doola, you can choose a unique name for your LLC, register it with your state, obtain a registered agent service, create an operating agreement, get an EIN, open a business bank account, access legal templates and resources, and more.
No need to hire a lawyer or deal with complicated paperwork. You can do everything from the comfort of your home or office. Sign up for a free consultation with doola today and get your LLC up and running in no time.
How does an LLC protect my personal assets?
An LLC protects your personal assets by creating a legal separation between you and your business.
Are there any limitations to the liability protection an LLC provides?
While an LLC offers liability protection, you may still be personally liable in certain circumstances like negligence or wrongdoing, personal guarantee of contracts or agreements, or if the courts decide to disregard the LLC’s existence.
Does liability insurance protect an LLC?
Yes, liability insurance can protect an LLC from various risks and losses due to accidents, disasters, lawsuits, thefts, or errors.
Can an LLC be sued?
Yes, an LLC can be sued by anyone with a legal claim against it, such as a customer, a supplier, a competitor, or a government agency.