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Hidden Risks of Personal Liability For LLC Owners

As a lawyer who helps launch hundreds of companies annually, I am often asked whether forming a limited liability company (LLC) will truly shield a company’s owner(s) from the risk of incurring personal liability. Very often, our clients are surprised to find out that the answer is “no” – forming an LLC only serves to limit personal liability with respect to the business in a few very specific, although important, ways.

LLCs Protect Owners from Most Business Debts

Although LLCs get their name from the fact that an owner’s personal liability is limited with respect to the business, that limitation applies mainly to liability for business obligations. For example, it’s true that the owner of an LLC will generally not be liable for the company’s debts or contractual obligations beyond the amount of their investment in the company. If the company fails altogether or defaults on a specific obligation, creditors will not usually be able to reach the business owner’s personal assets. That’s not to say creditors will not try to get at an owners assets. Forming an LLC does not mean that LLC owners will not get sued personally for business debts. They should be able to defeat those claims depending on whether they managed the company properly. In this sense, forming an LLC is often a good partial strategy for managing the most fundamental risk associated with owning a business – that it could ultimately fail.

Some Risks Remain with the Business Owner

Business owners should be aware that forming an LLC will not necessarily protect the owner from liability related to personal injury or other harms caused by business activities. Although ownership by itself generally will not render the LLC’s owner(s) personally liable for these harms, the mere fact that the LLC exists does not always shield the owner from personal liability if the owner is personally involved with the activity that causes injury. For example: if the owner of an LLC drives a company car to a business meeting and negligently causes an accident along the way, both the business and the owner are likely to be liable. The owner will not be able to claim that the LLC’s existence absolves them from personal liability because the owner was personally negligent in their operation of the company car. The injured party will likely sue both the company and LLC owner for damages.

This is one reason why we caution entrepreneurs whose business is almost entirely delivered by the owner’s personal efforts. The limited liability aspect of an LLC offers little protection to owners personally deliver the services their business sells. A contractor who causes damage to a home will not be protected; an Uber driver who causes an accident will not be protected. As such, it’s important for an entrepreneur to thoroughly consider what risks are inherent to his or her business as well as what his or her personal relationship to those activities will be. Even if the owner plans to have no direct involvement with business activities that carry obvious risks of injury to others, there will still likely be some residual risk of personal liability, particularly for start-ups that often rely on its owners to wear many different hats.

How to Mitigate Residual Risks

There are a number of ways that these residual risks can be mitigated. Two that often prove useful are for the company to maintain adequate liability insurance and contractual provisions that limit damages claims. If there are multiple owners of the LLC, it’s a good idea to ensure that the company’s operating agreement adequately addresses when and how the company will indemnify owners for personal liability incurred in the course of business. Each business has a unique risk profile and it can often be helpful to work through these issues with an experienced attorney in order to ensure that the company’s governing documents include appropriate safeguards regarding the apportionment of liability.

The experienced business attorneys at Fiffik Law Group regularly help entrepreneurs and start-up companies navigate the complex legal issues that arise during a company’s formation and early growth stages. If you would like to speak with one of our attorneys, please contact us today.

1 Comment

Michael, I really enjoyed this article and would hope every associate who wants to sell to small biz owners, also reads it. The part where you talked about internal VS external liability is something very few know anything about, but should. Liability insurance and contractual provisions were just recently discussed among some fellow business owners and really make us think and strategize better. Lastly, my favorite, the indemnity spelled out in the Operating Agreement. I preach and preach the absolute necessity of the OA, and why I've gently and strategically brought it up in posts about Launch. That program does not provide this crucial document, and puts business owners who use it, at significant risk. I can share my thought…

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