When an LLC doesn’t protect personal assets

Limited liability companies (LLCs) are a common way for real estate owners and developers to hold title to property. Their popularity is due, in part, to the fact that LLCs limit members’ personal liability. In other words, only an LLC member’s equity investment is usually at risk, not his or her personal assets. However, this doesn’t mean personal liability never exists for the LLC’s debts and liabilities. Here are some of the exceptions that may jeopardize an owner’s or developer’s personal finances.

Making personal guarantees and contracts

If LLC members personally guarantee the company’s debts or obligations, they’ll be held liable for the LLC’s nonpayment or breach. This is more common than you may think: Many LLC members enter contracts or financing agreements on the LLC’s behalf before the LLC legally comes into existence if the other party insists on some guarantee.

To minimize the risk of personal liability, always act in the LLC’s name. When you sign contracts, for example, do so solely as an agent of the LLC, making sure to identify the LLC as the principal in the document. Similarly, make sure that the LLC’s other agents and employees act as representatives of the entity, not of you personally. For extra protection, members might consider adding a personal umbrella policy to the LLC’s traditional business insurance coverage.

Certain loan defaults may also create personal liability. Carefully review all loan documents to make sure you completely understand the consequences of all potential covenant violations.

Paying for environmental cleanup

Environmental liability is a common concern when purchasing property, and using an LLC to make a sale or purchase doesn’t eliminate that concern. The Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA) imposes strict, joint and several liabilities for cleanup costs on past and present owners and operators of facilities where hazardous materials have been released.

When it comes to holding LLC members personally liable, no showing of negligence or intent is required under CERCLA. Any LLC member who had the authority to control the operations or decisions involving the disposal of hazardous substances could be held liable for cleanup.

Finding negligence and wrongful acts

An LLC won’t protect a member from liability for his or her own negligent or otherwise wrongful acts that cause injury to another, such as assault or fraud. That could include negligent hiring or supervision of employees if an employee causes some type of injury and the member hired the employee in his or her own name, rather than in the LLC’s name.

Also note that, if an LLC member commits a wrongful act that causes injury while acting as an agent or employee of the LLC, it’s not just the member’s personal assets that could be targeted by the injured victim. The victim could also go after the LLC’s assets, under a theory of vicarious liability (also known as “respondeat superior liability”) for its agent’s acts.

Piercing the corporate veil

On rare occasions, a court will “pierce the corporate veil” to impose liability for an LLC’s debts and obligations on its members. This typically occurs when closely held and small businesses fail to observe corporate formalities such as holding regular board meetings, keeping minutes, adopting bylaws and ensuring company finances are separate from those of members. It could also happen if the LLC engaged in reckless conduct or fraud or was inadequately capitalized from the beginning.

In all of these circumstances, a court might conclude that the LLC is merely a sham to shield its members from liability. Once a court makes that determination, LLC members’ personal assets can be used to satisfy LLC debts.

Cover your assets

Think an LLC might work for your next real estate venture? While these entities offer many benefits, don’t overlook possible personal liability risks. LLC rules vary by state; so, be sure to research your jurisdiction. Consult with your attorney and financial expert to create strategies to protect both your LLC and your individual assets.