The goal of the Limited Liability Company (LLC) is to protect your personal assets if someone tries to sue your company. However, just as Superman has his kryptonite or Achilles has his heel, so too can your LLC have holes in its protective powers.
If you want your LLC to protect you in the face of a lawsuit, then you need to ensure that all of the holes are identified and plugged, otherwise a court might be able to “pierce the veil” of your LLC protection and in doing so come after your personal assets.
What Are The Holes in Your Liability Protection?
Piercing the veil of a company’s protection typically happens from one of two causes.
- The court finds that there is a lack of adequate capitalization.
- The court finds that the LLC is used as a front in an effort to pursue personal gain or otherwise personal affairs.
In short, the court is looking for the appearance of fraud. Since appearances can be deceptive, make sure yours looks good by asking the following types of questions:
- Was enough money contributed at the creation of your LLC?
- Was the amount contributed enough to realistically run a business?
- Are you unable to pay vendor’s bills due to purchased or rented services or goods?
- Have you completed all state filings accurately (and on-time)?
- Did you falsely represent your ability to pay back business credit?
- Are there sufficient funds to pay debts after paying LLC members?
- Are any personal bills paid with the LLC checks or funds?
- Do you have accurate (and properly filed, stored, and shared) meeting minutes regarding company decisions?
- Do you have accurate records, especially as denoted within the LLC Operating Agreement?
- Are all members operating within the parameters set forth by the operating agreement?
The answers to the above questions will help you to identify areas of weakness that could allow a court to pierce the veil of your LLC’s protection.
How Can You Increase Protection Using Your LLC?
The first step to using your LLC for your personal liability protection is to create your LLC to your advantage, and then to stay on top of the periodic filings required. See this example of forming an LLC in California for tips on what to consider in advance. Ensure that you keep business actions entirely separate from personal actions (especially those related to financial matters).
Commingling funds and blurring the line between personal and business efforts is a danger. Courts will sometimes find with real estate investments, which are commonly held in LLCs, that the owner is too involved in the daily management of them, and loses the claim that the business entity owns them. Such owners might be advised to use a property manager and a tenant screening service, and other such contractors to stay personally removed from the operation. Keeping business and personal matters separate is probably the one most essential rule of conduct here.
The best way to keep this separation strong is to keep a clear paper trail of every company action, as well as the reasons behind those actions. In this vein, always think in terms of the paper trail you’re leaving with all your business activities. This paper trail should include meticulous records that justify your business actions. Remember, in order to pierce the veil, the court has to find that fraudulent activities were taking place or that you were falsely using the LLC to advance personal gains. A paper trail of conduct can help to keep you safe.
Follow These Key Paper Steps to Help Your LLC Protect You
Keeping a meticulous and organized paper trail of conduct can increase your liability protection. The common components of your paper trail should include the following:
- A properly and legally filed business name. In some cases you may also consider an international trademark or registered name for your business.
- You must file all forms properly. These forms may vary based on the state where your LLC is created, but you can be sure there’s an EIN (Employer Identification Number) and the all-important Operating Agreement.
- There will be periodic reports and filings required by the state (and of course by taxing authorities), and your business will need to remain in Good Standing.
- The operating agreement should clearly articulate shareholder and member roles, spell out how records are maintained, and state how decisions are made.
- Members of the LLC should follow the duties of the operating agreement diligently: one delinquent member can expose all the members to liability.
Finally, LLCs often run risks when they fail to identify intellectual property rights and to claim them to the company or specific members. Avoid this risk through various agreements such as a Non-Compete Agreement, Non-Disclose Agreement, or Intellectual Property Assignment Agreement.
Help Your LLC Protect You by Learning to Love Paperwork
If you want your LLC to protect you, then you need to love paperwork. In fact, a paper trail of conduct can be the saving grace if your LLC ever faces a lawsuit. When in doubt, ensure that every action is accountable via a legal, meticulous, and properly filed paper trail.
Of course, you can also safeguard your assets by working with trusted professionals to ensure that your LLC is properly following all stated rules, regulations, and guidelines – and since nothing here should be construed as legal or accounting advice, the best advice is never to hesitate to seek professional accounting and legal advice for every area of uncertainty.