LLC Limitations

Your LLC’s Liability Might Not Be Limited 

By Jill Douthett 
Limited liability companies are the flavor of the month for creating new businesses or reorganizing existing ones. They are easier and cheaper to form and manage than corporations, and yet they offer protection of members’ personal assets, unlike a sole proprietorship or general partner arrangement.

But too many do-it-yourselfers file their articles of organization and then fail to take the steps necessary to ensure they will enjoy the limitations on personal liability that the LLC structure was designed to offer. Here are just some of the most common problems:

Undercapitalization. If you don’t sufficiently capitalize your LLC with property, cash or other assets, the courts may disregard your company structure and permit creditors, injured persons or other claimants to sue members directly. At the very least, you must buy sufficient insurance in your LLC’s name to respond to personal injury claims and property losses.

Failure to observe formalities. An LLC can be so easy to form and manage that people sometimes forget it is a separate legal entity. If you don’t scrupulously observe the rules, the LLC structure may be disregarded because those who deal with you are not on notice that you are doing business in a limited liability capacity. So set up separate bank accounts for your LLC; never mingle personal and LLC assets; use your chosen LLC designation on all your stationery, documents, directory listings, Internet sites and everywhere else; and be sure you sign checks, correspondence, contracts, leases and all other business documents as a “Member” or “Manager” of the LLC, as the case may be.

Doing Too Much. This is a first cousin of the previous. People sometimes try to operate too many different businesses under the same LLC, and they end up resorting to “doing business as” designations when conducting those separate activities. It is far better for you or your original LLC itself to organize additional LLCs to conduct those other businesses.

Nonpayment of taxes. There’s no liability limited enough to protect you if you don’t withhold and pay your payroll taxes for any employees you hire.

Lack of an operating agreement. Even if you’re protected against claims from outsiders, disputes that arise among members over management decisions, distributions and a host of other issues can result not only in messy and costly litigation but personal exposure if you don’t have an internal operating agreement to address them and if your members don’t understand their fiduciary obligations to one another. It’s not fun to think ahead to the possibility that such disputes may arise, but operating agreements are as critical as buy-sell and pre-nuptial agreements are in other contexts.

Business contracts. Just because you’ve reorganized, it doesn’t mean your existing contracts and obligations belong to the LLC. As just one example, if you signed your lease in your name before the LLC was formed, in all likelihood the landlord is perfectly entitled to look to you personally for the rent.

Personal guarantees. Sadly, when it comes to borrowing money from a bank or other lender, most of us will be required to sign a personal guarantee. So you may find you have done everything you were supposed to do in setting up and running your LLC, only to be personally on the hook for your LLC’s biggest financial liability.

Even with these and other potential pitfalls, the limited liability company is a terrific business form suitable for a variety of enterprises from home-based businesses to commercial real estate development. But you have to know the rules, and you have to follow them.