Many of our clients are interested in forming a Limited Liability Company (LLC) “LLC”) as the name of their company. Many lawyers and accountants advise Illinois small business owners to form an LLC because it provides them with the restricted liability of a corporation while also providing them with the tax benefits of a partnership’s flow-through taxes.
The fundamental goal of forming an LLC is to shield members and investors from personal liability arising from the business’s creditors’ claims, as well as to safeguard their personal (and family) assets from creditors’ claims.
Members of an LLC, in general, have limited responsibility and cannot be sued personally for the LLC’s activities or debts. To put it another way, “The LLC legal structure’s “corporate veil” protects its members from personal accountability. The LLC’s members and executives are protected from the company’s commercial debts by the veil. In addition, “piercing the veil” creditors try to get around the common rule that the LLC’s debts are not personally liable. The Illinois Limited Liability Act even states that members of an LLC are not individually accountable for the company’s debts unless the members agree to be personally liable in the Articles of Organization.
However, recent judgments raise the question of whether members are always immune from personal accountability. The previous cases haven’t put a stop to it “An LLC’s “veil piercing” Although no case in Illinois has enabled attempts to pierce an LLC’s veil, courts are debating whether and how to allow the piercing of the LLC structure’s veil. It is still feasible that members of an LLC could be held personally accountable for the Company’s debts until the Illinois Supreme Court answers the question with a definitive judgement.
- A unity of interest and ownership is required so that the firm seems and operates like the individual’s — a unity of ownership.
- There are circumstances that suggest there is no distinction between commercial operations and personal affairs of persons.
If the LLC does not follow the formalities and legal requirements for the operation of the business, one of the ways these requirements can be met is if the LLC does not follow the formalities and legal requirements for the operation of the business. The LLC should issue membership certificates, sufficiently capitalize the LLC, hold annual meetings, keep meeting minutes, use a separate bank account for all LLC activities, pay creditors before paying distributions to members, and adhere to the LLC Operating Agreement’s conditions. To put it another way, the LLC’s lawyer should help protect you from personal liability by ensuring that your LLC adheres to all of the legal requirements for maintaining your status as an LLC.
Who is liable for the debts of an LLC?
People form LLCs primarily to protect themselves from personal accountability for the debts of a firm they own or are involved in. By incorporating an LLC, only the LLC—not the owners or managers—is responsible for the business’s obligations and responsibilities. However, an LLC’s limited liability isn’t ideal, and it can vary depending on the state in which it’s formed.
Before you start your firm, think about the various liability concerns your company may face and the protection you’ll obtain from an LLC. In particular, as an LLC owner, you should consider the following liability risks:
1) You are personally liable for the debts of your LLC.
2) Personal liability for business-related conduct by LLC co-owners or employees
3) personal culpability for your own business conduct, as well as
4) The LLC’s accountability for the personal debts of other members.
Is a member of an LLC personally liable?
When a firm forms an LLC, its owners are shielded from personal liability for any crime committed by the LLC’s workers or co-owners while the organization is in operation. If the LLC is proven accountable for an employee’s or owner’s malfeasance or negligence, the money in the LLC can be confiscated in a judgment against the company. The owners, on the other hand, will not be held personally accountable for the debt.
An employee could face personal liability for his activities, but an LLC co-owner who was not involved would not. If an employee drives over someone during a delivery and that person dies, the corporation could be held accountable if the employee was inebriated at the time. If a lawsuit is filed, the company’s money and assets will be utilized to pay the verdict, but the LLC co-personal owner’s assets would not.
Can members of an LLC be sued personally?
If you form an LLC for yourself and use it to conduct all of your business, the LLC will be held accountable in a lawsuit, but you will not. Using an LLC to run your own business offers no protection against a tort verdict, which is the type of liability that most people are concerned about.
What happens to debt when LLC is dissolved?
A limited liability company’s debts are not discharged when it is dissolved. When the members of an LLC decide to dissolve it, they must begin “winding up” the LLC’s operations. Discharging the LLC’s debts and contractual obligations, which may include marshaling its assets to meet its obligations in accordance with the law’s priorities, is one of the tasks included in the winding-up process. We’ll use the Revised Uniform Limited Liability Company Act to illustrate the normal approach because many states utilize it as a model for their own laws.
What is the downside to an LLC?
The liability protection, managerial flexibility, and tax advantages that a limited liability corporation (LLC) often affords make it a popular choice among small business owners. Understanding the pros and cons of forming an LLC, as well as how to form an LLC, where to form an LLC, and other important subjects, is critical for business success.
What is an LLC?
A limited liability company (LLC) is a type of business structure that provides limited liability protection as well as tax pass-through. The LLC, like corporations, is a legal entity independent from its owners. As a result, owners are rarely held personally liable for the company’s debts and liabilities.
The LLC provides for pass-through taxes because its income is not taxed at the entity level; nevertheless, if the LLC has more than one owner, the LLC must file a tax return. Any LLC profit or loss reported on this form is passed on to the owner (s). The owners, also known as members, are then required to disclose the profit or loss on their personal tax returns and pay any applicable taxes.
The advantages of incorporating an LLC over operating as a sole proprietorship, general partnership, or corporation often outweigh any apparent drawbacks.
- Limited liability: Members (who are the LLC’s owners) are protected from personal liability for the LLC’s and its other members’ actions. Creditors can’t go after the owners’ personal assets (houses, savings accounts, etc.) to pay off corporate debts. On the other hand, sole proprietors and general partners’ personal assets might be used to pay off the company’s debts. Note that an LLC (as well as a corporation) can lose its limited liability status. This is referred to as “piercing the curtain.” See How to Avoid Piercing the Corporate Veil for more details.
- Individuals, partnerships, trusts, and corporations can all join, and there is no limit to the number of people who can join. Who can be a shareholder in a S corporation (a corporation that has decided to be taxed as a pass-through entity under Subchapter S of the Internal Revenue Code) is much more limited, and there is a maximum number.
- Members can administer the LLC alone or pick a management committee to do so. Corporations, on the other hand, are run by a board of directors rather than by shareholders.
- LLCs often do not pay taxes at the business entity level, which is known as pass-through taxation. Any profit or loss made by the firm is “passed-through” to the owners and reported on their personal tax returns. Any taxes owed are paid on an individual basis. Corporations that can’t or don’t want to be taxed as S corporations (they’re called C corporations since they’re taxed under IRC Subchapter C) are taxed at the business entity level, and their shareholders are taxed on the income they get.
- Increased credibility: Organizing a limited liability company (LLC) can assist a new firm acquire credibility faster than operating as a sole proprietorship or partnership.
- Limited compliance requirements: Compared to sole proprietorships, general partnerships, and corporations, LLCs have less state-imposed compliance requirements and ongoing formality (whether taxed as S corporations or C corporations).
Disadvantages of creating an LLC
There are a few negatives to forming an LLC, but in most circumstances, the benefits outweigh the drawbacks.
- Cost: Forming and maintaining an LLC is usually more expensive than forming and maintaining a sole proprietorship or general partnership. A one-time formation fee is charged by each state. Many states additionally charge recurring costs like annual report and/or franchise tax payments. Consult your Secretary of State’s office for more information.
- Ownership is transferable. An LLC’s ownership is often more difficult to transfer than a corporation’s. Shares of stock can be sold by firms to increase ownership, and shareholders can sell their shares to someone else unless there is a shareholder agreement to the contrary. Unless the members agree differently, all members of an LLC must authorize adding new members or changing the ownership percentages of current members unless the members agree otherwise.
How to form an LLC
Although it is often easier to organize a partnership than a corporation, some administrative and regulatory duties must be completed. Follow these eight steps to incorporate an LLC successfully and in accordance with state legislation.
Although an LLC can be formed in any state, even if it won’t be doing any business there, most LLC owners opt to register one in the state where they expect to do business, which is often their home state. One reason for this is that if the LLC is formed in a state where it will not be doing business—Delaware is the most common choice for these LLCs—the LLC will be required to register as a foreign LLC (also known as a foreign qualify) in the state where it will be doing business, which can increase formation and administrative costs.
What happens if a company Cannot pay its debts?
If a company fails to make due debt payments or fails to communicate with creditors, the company’s creditors may file a lawsuit to recover the money owing. If a creditor wins a court judgment against a company, the creditor can garnish the company’s bank accounts and confiscate its assets to pay the debt. In a civil judgment, the total owing for an unpaid debt is frequently increased to include unpaid interest, collection costs, and attorney fees. A civil judgment is public information, and it may have an impact on the company’s capacity to obtain financing from other lenders.
What are the responsibilities of LLC members?
The basic legal obligation of an LLC is to pay and satisfy its debts and contractual commitments. An LLC, as a corporate entity, has the authority to do many of the things that an individual may, such as borrow money, own real estate, make contracts, hire workers, and hire contractors. In exchange for the ability to incur liabilities, there is a legal obligation to fulfill the obligations that come with them, such as making regular loan payments, performing under contracts, paying wages to employees and withholding taxes, and compensating contractors.
In addition, like other commercial entities, an LLC is legally liable for the activities of its employees while on the job. If an employee’s employment entails delivering products to consumers, for example, the company is liable if the person causes a car accident while driving their route. However, if an employee causes an accident while doing a personal errand, the company will not be held accountable.
If there are defaults or failures to perform, an LLC member is not accountable for the company’s debts and obligations unless the member has legally agreed to guarantee or otherwise stand behind the business’s liabilities.
What happens if someone sues my LLC?
In the event of a lawsuit, there are several things you can take to safeguard both your personal assets and those of your LLC. The majority of them are things you should do before you get sued. A skilled company lawyer can assist you in establishing an asset protection plan for your LLC so that you are ready for whatever the future holds.
Get Good Liability Insurance
Your LLC, as well as its owners, should be covered by liability insurance. If your LLC is sued, a ruling against it might bankrupt or deprive your company of its assets.
Similarly, if the lawsuit is based on anything you did—for example, carelessly injuring a customer—the plaintiff may pursue you personally if the insurance does not cover their damages.
Don’t Mix Personal and Business Assets
It’s critical to keep your professional and personal assets separate if you want to avoid alter ego lawsuits. Keep meticulous records. Paying personal credit cards or debts with LLC funds is not a good idea.
Put company assets, such as automobiles and equipment, in the company’s name. Leases, credit cards, bank accounts, and other accounts should all be in the name of the company.
Build Your LLC’s Credit and Pay Off or Refinance Debts You Have Personally Guaranteed
To persuade a bank to give a loan to an LLC when you first start a business, you may have to personally guarantee the loan. However, you must put up personal assets as collateral, such as your home. This is a frightening circumstance, and you don’t want it to last any longer than it has to.
Pay all of your LLC’s bills on time to improve your LLC’s credit. Keep meticulous records of your revenues and losses to demonstrate to banks that your LLC is viable. When your LLC’s credit is solid enough, pay off or refinance those early loans to lessen your personal liability.
Don’t Keep Too Much Money in the LLC
All LLC funds can be utilized to pay off debts owed to the company. Although you must have enough monies in the LLC accounts to fulfill the LLC’s bills, wages, and other obligations, having too much money in the LLC accounts can leave the LLC susceptible.
You should undoubtedly think about either distributing additional earnings as profits or reinvesting them to build your company.
Put Personal Assets in a Trust
There may be other procedures you can take to protect your personal assets beyond the liability shield provided by your LLC. You might be able to put them in a trust, for example.
This is a step you should do long before your creditors contact you. It may be considered fraud if you shift your assets elsewhere immediately before defaulting on a debt. A skilled company attorney can assist you in determining which technique is best for your situation.
Use a Series LLC
A specific sort of LLC known as a series LLC is permitted under Texas law. A series LLC can be divided into several sub-companies with their own accounts, assets, and functions. If one of the sub-companies is sued, the assets of the other sub-companies are protected.
Can a manager of an LLC be personally liable?
- Investing money (Capital Contribution). An LLC’s Owner/Member is always at risk of losing their monetary investment in the company. That is something that a limited liability company (LLC) cannot prevent. The Owner(s)/Member(s) lose their money if the firm fails. However, that is usually the limit of their exposure.
- Other Owners’/Members’ Liability. Except in the case of criminal actions or gross negligence, an LLC Owner/Member is usually not personally accountable to the other LLC Owner(s)/Member(s).
- Contract Law’s Liability to Third Parties In general, an Owner/Member is not personally liable under a contract executed by the LLC on behalf of the LLC Manager(s). This is true only if the contract does not require a personal guaranty, such as in the case of a business loan or other form of financing. The Owner/Member who personally guarantees the loan will be personally liable for the debt obligation in this case.
- Tort law liability to other parties. An LLC Owner/Member is not liable for a tort committed by the Company or under the LLC Manager’s direction, or for a tort committed by the LLC Manager acting beyond the boundaries of the Manager’s power. An LLC, on the other hand, is not a license for an Owner/Member to commit criminal or even careless acts, especially if the LLC is Member-Managed and the Owner/Member is also the LLC Manager and/or has direct transactions with third parties on behalf of the LLC. If the Owner/Member has taken activity that resulted in a tort against a third party, the Owner/Member may be held personally liable.
- As a professional, you are liable to third parties. An LLC will not insulate its owner(s)/member(s) from malpractice and related negligence if they are licensed professionals such as doctors, lawyers, accountants, and so on. This is a good example of how, regardless of the type of business, insurance is always necessary.
In some ways, the manager(s) of an LLC are protected from liability in the same way that the CEO or Chairman of a company is. The policy underpinning this protection is in place so that a firm can hire the best and brightest people to manage and execute its day-to-day operations without fear of personal liability:
- Under Fiduciary Law, the Owners/Members are liable. The LLC Manager typically has a fiduciary duty to the Company and hence serves the interests of all of the Owners/Members. Liability may arise if the LLC Manager violates his or her fiduciary duties. A fiduciary obligation is a combination of a duty of care and a duty of loyalty. In the case of a duty of loyalty, it is an obligation to put the LLC’s interests ahead of one’s own, which means any conflict of interest must be reported, however a disclosed conflict of interest can usually be waived in the LLC Operating Agreement.
- Contract Law’s Liability to Third Parties A Manager who executes a contract on behalf of the LLC has no personal accountability to the other parties involved in the deal. However, as previously stated, this is only true if the LLC Manager does not personally guarantee the contract, whether it be a loan, lease, or other type of agreement, and only if the LLC Manager is permitted to enter into such an agreement on the LLC’s behalf.
- Third-Party Liability under Tort Law A Manager is typically indemnified by the LLC for activities she does while acting in her capacity as Manager. One of the advantages of having an LLC is that it allows the manager to run the company without worry of personal liability. A Manager, on the other hand, may be held personally accountable for illegal behavior and purposeful acts that go outside of the area of his or her authority.
As you can see, LLC liability is not as straightforward as it may appear. In addition, the focus of this essay is on the personal culpability of LLC owners and managers. The Company’s liability is a different problem, such as when an employee’s acts cause the Company to be held liable under the legal principle of Respondeat Superior, which is Latin for “don’t hire dummies” (it’s actually Latin for “let the master reply.”) However, with an LLC or another type of corporate entity that restricts the responsibility of the owners, only the Company, not the owner, is accountable for the negligent actions of the employees.
However, an LLC may be disregarded by a judge in a case involving the business in exceptional circumstances.
If this occurs, all of the LLC’s benefits outlined in this article will be lost.
This could happen if the LLC is being utilized to commit fraud, avoid the law, or for some other nefarious purpose.
This may also occur if the LLC is set up to be insolvent, i.e., not appropriately capitalized, or if personal and corporate interests are so entwined that the LLC lacks a distinct identity.
Also, except where prohibited by law, part of what has been mentioned herein can be amended in the LLC Operating Agreement.
Furthermore, LLCs are often governed by state law, which differs from state to state.
Can LLC members sue each other?
LLCs have an Operating Agreement, which is similar to the Partnership Agreement that is established before forming a partnership. Members of an LLC can only sue one another in certain situations if they can show that they have been personally affected in addition to the other members or the business.
Can I close my company if I owe money?
In short, yes, you can close a limited company with debts and start over, but there are tight procedures to follow, and the repercussions can be severe if it is claimed that it was done fraudulently.
If you are the director of a company that is being crushed by massive debts, closing it may be the best option so that you may start a new business without having to worry about the debts and other issues that come with them.
What are the major advantages and disadvantages of an LLC?
- Profits are dispersed to members, who are taxed on profits at their personal tax rate. This eliminates the need for double taxation.
- This is the best way to invest in appreciating assets like real estate, stock portfolios, and intellectual property.
- Extremely flexible in terms of allocating profits and losses to members in different quantities.
