Requirements For Asset Protection
One of the main attractions of limited liability companies is the personal liability protection they provide.
When you form an LLC, you establish a separate legal entity that is responsible for its own contracts and other obligations. Because the LLC’s owners (known as members) are legally separate from the LLC itself, they are generally not personally responsible for the LLC’s debts and other obligations.
But this LLC protection is not absolute. There are certain instances where members’ personal assets may be used to satisfy business obligations. For example:
- Members are always liable for their own negligence or intentional actions.
- Members may also be held personally liable if they don’t take steps to maintain the LLC’s status as a separate legal entity.
- Members’ assets are at risk if they personally guarantee a debt.
Fortunately, there are steps you can take to maximize your LLC’s asset protection benefits.
LLC Protection Against Negligence
LLC asset protection does not protect an LLC member from his or her own improper actions. Those actions can include deliberate acts, such as defrauding a customer, but they can also include things that happen by accident: a wreck involving a company car, a customer who slips and falls, or a product that malfunctions and injures someone.
When these sorts of things happen, the LLC’s owners can be sued on a theory of negligence, meaning they weren’t as careful as they should have been. And that can put the owners’ personal assets, as well as the assets of the business, at risk.
The first line of defense against these sorts of claims is to be careful and ethical in all your dealings. But LLCs should also protect themselves and their members with liability insurance that can pay claims and cover the costs of defending a lawsuit.
Preserving LLC Liability Protection
When LLC members don’t keep business and personal affairs separate, a creditor may ask a court to rule that the LLC is just an “alter ego” of its members. Under this theory, a court may disregard the LLC as a separate entity and hold the members personally responsible for business obligations.
There are several steps that LLCs can take to prevent this from happening. First, LLCs should open a business bank account and keep LLC money completely separate from members’ personal finances. The LLC should have sufficient funding to meet its obligations – undercapitalization can be a basis for alter ego liability.
LLCs should also have an operating agreement that specifies how the LLC should be operated, and members should follow procedures outlined in the operating agreement.
Finally, everyone the LLC does business with should understand that they are dealing with an LLC. Make sure your contracts are signed on behalf of the LLC and include the LLC designation on written business materials such as forms, invoices, purchase orders, correspondence, business cards, websites and marketing materials.
Avoiding the Personal Guarantee
A new LLC that needs to borrow money or lease office space may lack the assets and good credit history that lenders and landlords require. To get financing, LLC members may be asked to sign a personal guarantee. If the LLC cannot pay its obligations, a creditor can try to recover money from the members who signed the guarantee.
If you are a brand new business owner, there’s probably not much that you can do to avoid personal guarantees. But you can begin to build business assets and a credit history that may allow you to avoid using your personal assets to guarantee business obligations in the future.
Once your business is well-established, you can consider more complex asset protection LLC strategies such as trusts and putting money into assets that are exempt from LLC liability. A lawyer or tax professional can advise you on whether these strategies might be appropriate for you.