LLCs and Limited Liability Protection
As the name implies, limited liability companies (“LLCs”) are limited liability entities that protect their owners (also called members), managers, and the LLC itself from certain types of legal liability. But just what is this limited liability, and how limited is it really?
What Type of Liability Protection Do You Get With an LLC?
The main reason people form LLCs is to avoid personal liability for the debts of a business they own or are involved in. By forming an LLC, only the LLC is liable for the debts and liabilities incurred by the business—not the owners or managers. However, the limited liability provided by an LLC is not perfect and, in some cases, depends on what state your LLC is in.
Before you get started on your business venture, you’ll want to consider the potential liability risks of your business and the protection you’ll get from an LLC. Specifically, you should think about the following liability risks you take on as an LLC owner:
1) personal liability for your LLC’s debts
2) personal liability for actions by LLC co-owners or employees related to the business
3) personal liability for your own actions related to the business, and
4) the LLC’s liability for other members’ personal debts.
Personal Liability for Your LLC’s Debts
In all states, if you form an LLC to operate your business, and don’t personally guarantee or promise to pay its debts, you will ordinarily not be personally liable for the LLC’s debts. Thus, your LLC’s creditors can go after your LLC’s bank accounts and other property, but they can’t touch your personal property, such as your personal bank accounts, home, or car. Many creditors, however, don’t want to be left holding the bag if your business goes under so they will demand that you personally guarantee any business loans, credit cards, or other extensions of credit to your LLC. In that situation, you would be personally liable if your LLC’s assets fall short.
Personal Liability for Actions by LLC Co-Owners and Employees
In all states, having an LLC will protect owners from personal liability for any wrongdoing committed by the co-owners or employees of an LLC during the course of business. If the LLC is found liable for the negligence or wrongdoing of its owner or employee, the LLC’s money or property can be taken by creditors to satisfy a judgment against the LLC. But the LLC owners would not be personally liable for that debt. The owner or employee who committed the act might also be personally liable for his or her actions but a co-owner of the LLC who was not involved in the act or wrongdoing would not be.
Example: While making a bread delivery to a local supermarket, Lloyd, an employee of the Acme Bakery, LLC, runs over and kills a brain surgeon in a crosswalk. It turns out Lloyd was driving while drunk. Acme Bakery is sued and found liable for its employee’s negligent actions while on the job. All of Acme’s business property, assets, money, and insurance can be used to pay the judgment awarded to the surgeon’s heirs. Acme LLC’s owners, however, are not personally liable for the LLC’s employee’s actions so their personal assets cannot be taken to pay any judgment against Acme.
Personal Liability for Your Own Actions
There is one extremely significant exception to the limited liability provided by LLCs. This exception exists in all states. If you form an LLC, you will remain personally liable for any wrongdoing you commit during the course of your LLC business. For example, LLC owners can be held personally liable if they:
personally and directly injure someone during the course of business due to their negligence
fail to deposit taxes withheld from employees’ wages
intentionally do something fraudulent, illegal, or reckless during the course of business that causes harm to the company or to someone else, or
treat the LLC as an extension of their personal affairs, rather than as a separate legal entity.
Thus, forming an LLC will not protect you against personal liability for your own negligence, malpractice, or other personal wrongdoing that you commit related to your business. If both you and your LLC are found liable for an act you commit, then the LLC’s assets and your personal assets could be taken by creditors to satisfy the judgment. This is why LLCs and their owners should always have liability insurance.
Example: Assume that two of the three owners of Acme Bakery LLC (from the example above), knew that their driver was drunk, but let him make deliveries anyway. They can be sued and held personally liable for negligence by the brain surgeon’s heirs.
Your LLC’s Liability for Members’ Personal Debts
An LLC’s money or property cannot be taken by creditors of an LLC’s owner to satisfy personal debts against the owner. However, instead of taking property directly, there are other things that creditors of an LLC owner can do to try to collect from someone with an ownership interest in an LLC. What is allowed varies state by state and includes, in order of severity, the following:
getting a court to order that the LLC pay to the creditor all the money due to the LLC owner/debtor from the LLC (this is called a “charging order”)
foreclosing on the owner/debtor’s LLC ownership interest, or
getting a court to order the LLC to be dissolved.
None of these actions are good but some are much worse than others. If an LLC interest is foreclosed upon, the foreclosing creditor becomes the permanent owner of all the debtor-member’s financial rights, including the right to receive money from the LLC. If a court orders an LLC dissolved, it will have to cease doing business and sell all of its assets.
State LLC laws vary widely on how many of these steps creditors are allowed to take. All states allow creditors to obtain a charging order against an LLC owner’s interest. Many states limit creditors remedies to this first step (obtaining a charging order). Other states allow creditors to foreclose on the owner’s LLC interest or even can order the LLC dissolved to pay off an owner’s debt. For more on charging orders and what personal creditors’ of LLC owners can–and can’t–do, including the state law variations, see LLC Asset Protection and Charging Orders: An Overview of State Laws.
Single Member LLCs and Asset Protection
In some states, it’s not clear whether single member LLCs will receive the same liability protection from personal creditors of the LLC owner as multi-member LLCs. The rationale for limiting an LLC member’s personal creditor’s remedies to a charging order is to protect other LLC members from having to share management of their LLC with an outside creditor. There are no other LLC members to protect in a single member LLC so the rationale for limiting creditors’ remedies to a charging order doesn’t apply. For this reason, courts in some states have found that single member LLCs are not entitled to the charging order protection and creditors are entitled to pursue other remedies against the LLC member, including foreclosing on the member’s interest or ordering the LLC dissolved to pay off the debt.
A limited liability company (LLC) has been described as a “hybrid” between a partnership and a corporation. It enjoys the “pass-through” tax treatment of a partnership with the limited liability accorded corporate shareholders. [See Corps.C. § 17701.01 et seq.; Ontiveros v. Constable (2018) 27 CA5th 259, 273, 237 CR3d 892, 901-902; Western Surety Co. v. La Cumbre Office Partners, LLC (2017) 8 CA5th 125, 131, 213 CR3d 460, 464; People v. Pacific Landmark (2005) 129 CA4th 1203, 1211-1212, 29 CR3d 193, 198; see also Robinson v. Glynn (4th Cir. 2003) 349 F3d 166, 168 (“LLCs are noncorporate business entities that offer their members limited liability, tax benefits, and organizational flexibility”)]
Members’ Limited Liability: Ordinarily, only the LLC can be held responsible for the entity’s debts. Subject to narrow exceptions, the LLC members are not personally liable for the LLC’s obligations and/or liabilities and thus enjoy the same “limited liability” as corporate shareholders. [Corps.C. § 17703.04
5. [6:9] Centralized Management Optional: All of the members may partake in management of the LLC (akin to a general partnership) or may, in the LLC’s articles of organization, provide for centralized management (akin to a limited partnership or, in certain respects, a corporation). See discussion at ¶ 6:450 ff.
a. [6:10] Caution—securities law considerations: Members who do not participate in LLC management may be deemed passive investors, and the membership interests may be deemed securities. See ¶ 7:81 ff.
6. [6:11] Flexibility: The LLC form provides far greater flexibility than a corporation or a limited partnership. For a comparison of the LLC form with the corporate and limited partnership forms of doing business, see Ch. 2.
7. [6:12] Separate Legal Entity: Like partnerships and corporations, an LLC is recognized as a legal entity separate and apart from its members. It has all the powers of a natural person in carrying out its activities, including to sue and be sued, make contracts, borrow and lend money, acquire and sell property, invest, make donations, etc. [See Corps.C. §§ 17701.04(a), 17701.05; PacLink Communications Int’l, Inc. v. Sup.Ct. (Yeung) (2001) 90 CA4th 958, 963, 109 CR2d 436, 439; Abrahim & Sons Enterprises v. Equilon Enterprises, LLC (9th Cir. 2002) 292 F3d 958, 962 (applying Calif. law)]
(Caution: The operating agreement may not vary the LLC’s capacity to sue and be sued in its own name; see ¶ 6:105.)
a. [6:13] No member claim to LLC assets: Like corporate shareholders, a member has no direct ownership interest in specific company property. Once members contribute assets to an LLC, those assets become assets of the LLC and not assets of the members. [Kwok v. Transnation Title Ins. Co. (2009) 170 CA4th 1562, 1570-1571, 89 CR3d 141, 147; Abrahim & Sons Enterprises v. Equilon Enterprises, LLC, supra, 292 F3d at 963]
8. [6:14] Perpetual Duration: An LLC has perpetual duration (unless the articles or operating agreement provide otherwise). [Corps.C. § 17701.04(c)]
MAINTAINING LIMITED LIABILITY PROTECTION
§13.2 A. Alter Ego Liability
Members remain subject to alter ego liability. The formation of an LLC generally shields its members and managers from personal liability for the acts of the entity, whether that liability arises in contract, tort, or otherwise. Corp C §17703.04(a). However, the California Revised Uniform Limited Liability Company Act (RULLCA) provides that the members remain subject to liability under the common law governing alter ego liability and subject to personal liability “under the same or similar circumstances and to the same extent as a shareholder of a corporation.” Corp C §17703.04(b). See §§6.25–6.31. See, e.g., Toho-Towa Co. v Morgan Creek Prods., Inc. (2013) 217 CA4th 1096 (alter ego finding with respect to three affiliated entities). This statutory language seeks to establish the same standard for disregarding the entity as is applicable to corporations. There is one exception: The failure of LLC members or managers to hold meetings or observe similar formalities will not be a factor establishing a member’s alter ego or personal liability if the LLC’s articles of organization or operating agreement do not expressly require that meetings of members or managers be held. Corp C §17703.04(b). See §6.31. For further discussion of the alter ego doctrine and of disregarding the corporate entity, see generally Organizing Corporations in California, chap 1A (3d ed Cal CEB). See also §§6.25–6.31.
Reverse veil piercing. For a case allowing potential alter ego liability with respect to an LLC for the obligations of a member (“reverse veil piercing”), see Curci Invs., LLC v Baldwin (2017) 14 CA5th 214. In Curci, the court noted that a creditor does not have the same options against a member of an LLC as it has against a shareholder of a corporation. “[I]f the debtor is a member of an LLC, the creditor may only obtain a charging order against distributions made to the member…. The debtor remains a member of the LLC with all the same rights to manage and control the LLC, including … the right to decide when distributions to members are made, if ever.” 14 CA5th at 223. The court therefore ruled that reverse veil piercing might be available. In contrast, reverse veil piercing was not allowed in Phillips, Spallas & Angstadt, LLP v Fotouhi (2011) 197 CA4th 1132 or Postal Instant Press, Inc. v Kaswa Corp. (2008) 162 CA4th 1510, but neither Phillips nor Postal Instant Press involved LLCs.
b. Alter Ego Doctrine
An exception to the general limitation on the personal liability of a member for the obligations of an LLC is set forth in Corp C §17703.04(b). Corporations Code §17703.04(b) provides that a member will be liable under the common law governing alter ego liability and also for any obligation or liability of the LLC (arising in contract, tort, or otherwise) in the same or similar circumstances and to the same extent as a shareholder of a corporation would be, with the following exception: If the articles of organization or operating agreement do not expressly require the LLC to hold meetings of members or managers, then the failure to hold meetings or to observe formalities relating to meetings is not to be considered a factor tending to establish that a member has personal liability for any of the LLC’s obligations or liabilities.
As discussed in §§6.26–6.31, the common law governing alter ego liability is part of the analysis in determining potential liability of shareholders. Accordingly, to determine the potential liability of a member for LLC obligations, the potential liability of shareholders for a corporation’s obligations should be analyzed. Under normal circumstances, shareholders’ liability is limited to their investment in the corporation. This protection from personal liability may be lost, however, if a court finds a basis for invoking the alter ego doctrine. Under this doctrine, a court may disregard the legal fiction of a corporation’s separate existence distinct from that of its shareholders and find shareholders personally liable for corporate debts and obligations if it would be inequitable not to do so. See generally Mesler v Bragg Mgmt. Co. (1985) 39 C3d 290, 301; Toho-Towa Co. v Morgan Creek Prods., Inc. (2013) 217 CA4th 1096 (alter ego finding with respect to three affiliated entities); Sonora Diamond Corp. v Superior Court (2000) 83 CA4th 523, 538.
NOTE: A variation of the alter ego doctrine known as reverse veil piercing (or reverse alter ego) occurs when a third party creditor of an individual shareholder is allowed to pierce the corporate veil in order to reach corporate assets. In Postal Instant Press, Inc. v Kaswa Corp. (2008) 162 CA4th 1510, 1512, the court of appeal rejected the doctrine, but in Curci Invs., LLC v Baldwin (2017) 14 CA5th 214, the court distinguished Postal Instant Press, holding that application of the doctrine to reach assets of an LLC was possible under the facts of that case.
§6.26 (1) Reason for Invoking Doctrine
The principal reason for invoking the alter ego doctrine is that failure to do so would work an injustice on the corporation’s creditors or other third parties. Misik v D’Arco (2011) 197 CA4th 1065, 1072; Zoran Corp. v Chen (2010) 185 CA4th 799, 810. Its purpose is to prevent corporate shareholders from attempting to use the corporation as a shield against liabilities that would otherwise inure to them personally. See, e.g., Minton v Cavaney (1961) 56 C2d 576 (tort claims); Minifie v Rowley (1921) 187 C 481 (contractual obligations).
§6.27 (2) Two-Pronged Test
As stated by the California Supreme Court in Mesler v Bragg Mgmt. Co. (1985) 39 C3d 290, 300 (citing Automotriz del Golfo de Cal. v Resnick (1957) 47 C2d 792, 796), there are two general requirements for application of the alter ego doctrine: “(1) that there be such unity of interest and ownership that the separate personalities of the corporation and the individual no longer exist and (2) that, if the acts are treated as those of the corporation alone, an inequitable result will follow.” Because the alter ego doctrine is equitable, its application varies according to the circumstances in each case. Misik v D’Arco (2011) 197 CA4th 1065, 1071. Although the doctrine does not depend on the presence of actual fraud, bad faith is an underlying consideration and is usually found in some form or another whenever the trial court has been justified in disregarding the corporate entity. Associated Vendors, Inc. v Oakland Meat Co. (1962) 210 CA2d 825. See §6.28.
§6.28 (3) Typical Fact Patterns
In Associated Vendors, Inc. v Oakland Meat Co. (1962) 210 CA2d 825, 838, the court analyzed a number of cases in which the corporate entity had been disregarded and produced the following list of factual circumstances, which can serve as a checklist for determining whether the alter ego doctrine might be applicable (210 CA2d at 838):
Commingling of funds and other assets, failure to segregate funds of the separate entities, and unauthorized diversion of corporate funds or assets to other than corporate uses;
Treatment by an individual of the assets of the corporation as his or her own;
Failure to obtain authority to issue stock or to subscribe to or issue the same;
Holding out by an individual that he or she is personally liable for the debts of the corporation;
Failure to maintain minutes or adequate corporate records and confusion of the records of the separate entities;
Having identical equitable ownership in the two entities, identical individuals having domination and control of the two entities, identical directors and officers of the two entities in supervision and management, or sole ownership of all of the stock in a corporation by one individual or the members of a family;
Use of the same office or business location or employment of the same employees or attorney;
Failure to adequately capitalize the corporation, or the total absence of corporate assets;
Use of a corporation as a mere shell, instrumentality, or conduit for a single venture or the business of an individual or another corporation;
Concealment and misrepresentation of the identity of the responsible ownership, management, and financial interests or concealment of personal business activities;
Disregard of legal formalities and failure to maintain arm’s length relationships among related entities;
Use of the corporate entity to procure labor, services, or merchandise for another person or entity;
Diversion of assets from a corporation by or to a stockholder or other person or entity, to the detriment of creditors, or manipulation of assets and liabilities between entities so as to concentrate the assets in one and the liabilities in another;
Contracting with another with intent to avoid performance by use of a corporate entity as a shield against personal liability or use of a corporation as a subterfuge for illegal transactions; and
Formation and use of a corporation to transfer to it the existing liability of another person or entity.
See also Toho-Towa Co. v Morgan Creek Prods., Inc. (2013) 217 CA4th 1096; Zoran Corp. v Chen (2010) 185 CA4th 799; VirtualMagic Asia, Inc. v Fil-Cartoons, Inc. (2002) 99 CA4th 228.
§6.29 (4) Source and Adequacy of Funding
Undercapitalization is commonly found in alter ego cases. See, e.g., Nilsson, Robbins, Dalgarn, Berliner, Carson & Wurst v Louisiana Hydrolec (9th Cir 1988) 854 F2d 1538, 1544 (applying California law); Minton v Cavaney (1961) 56 C2d 576. As stated by the court of appeal in Toho-Towa Co. v Morgan Creek Prods., Inc. (2013) 217 CA4th 1096, 1107:
Undercapitalization of the business, commingling of corporate and personal funds, and failure to observe the corporate formalities are examples of business practices that would leave individual shareholders vulnerable to a finding of alter ego liability.
However, if the LLC members have made an equity investment or provided other sources of funding for the company’s initial operations sufficient to permit it to operate as a viable business entity, the adequacy of funding requirement is ordinarily considered met. The initial funding of the company need not be solely through equity investments. A key test is whether the company had funds available (either as equity or as debt) for a sufficient period of time to enable it to begin its business and develop the business to the point of economic viability. See 2 Marsh, Finkle & Sonsini, Marsh’s California Corporation Law §16.22 (4th ed 2000).
§6.30 (5) Segregation of Personal and Company Affairs
Counsel should advise LLC members to keep their personal business carefully segregated from the company’s business. Personal funds or other assets of members should never be commingled with those of the company, and all dealings between members and the company should be at arm’s length and properly documented. See generally §6.28. See also Toho-Towa Co. v Morgan Creek Prods., Inc. (2013) 217 CA4th 1096 (although entities were formed as separate corporations, they were operated with integrated resources and exploited the same assets). It is particularly important that company assets not be used by the members for their personal benefit. See Riddle v Leuschner (1959) 51 C2d 574.
§6.31 (6) Observing Formalities
In the corporate alter ego context, a common trap for shareholders is neglecting corporate formalities. The sole or majority shareholder who runs the corporation “out of his back pocket,” fails to hold meetings, and does not keep adequate books and records is especially vulnerable. If such a corporation becomes unable to meet its obligations promptly, creditors may discover and use this disregard of corporate formalities as a significant reason for invoking the alter ego doctrine and obtaining a judgment against the shareholder. See Temple v Bodega Bay Fisheries, Inc. (1960) 180 CA2d 279. See also Counseling California Corporations §3.86 (3d ed Cal CEB) for a sample attorney-client letter containing a checklist for avoiding alter ego liability.
For LLCs, if the operating agreement does not require that meetings of members or managers be held, the failure to hold meetings or to observe certain formalities pertaining to the calling or conducting of meetings cannot be a reason for invoking the alter ego doctrine. Corp C §17703.04(b). See §6.25. Thus, unless members have a strong need to require that meetings be held at certain times, the drafting attorney should consider the benefit of a provision that allows for meetings to be held on an “as needed” basis. See, e.g., §§9.42, 9.55, 10.29. In any event, the company should maintain adequate books and records, not only to reduce the risk of a successful alter ego claim, but also to satisfy its statutory requirements. See Corp C §17701.13. See, e.g., §§9.48–9.52, 10.34–10.37. See also §13.16 concerning books and records.
§6.32 c. Forced Contributions
Any person with a claim against an LLC may enforce an existing obligation of a member to make a contribution to the LLC, or to return to the LLC money or other property paid or distributed to the member. Corp C §17704.03(c). See §§6.46–6.52 concerning a member’s obligation to make capital contributions. See §§6.53–6.58 concerning distributions to members. However, a creditor cannot enforce a conditional obligation of a member, such as an obligation to make a capital contribution following a discretionary call if the call has not occurred, unless the condition has been satisfied or waived. Corp C §17704.03(b).
§6.33 d. Return of Improper Distributions
Members are obligated to return distributions from an LLC if (Corp C §§17704.06(c), 17704.05(a)
The member had actual knowledge of facts indicating the impropriety of the distribution, and
After the distribution, either
The LLC would not be able to pay its debts as they become due in the ordinary course of the limited liability company’s activities; or
The LLC’s total assets would be less than the sum of its total liabilities plus the amount that would be needed, if the LLC were to be dissolved, wound up, and terminated at the time of the distribution, to satisfy the preferential rights on dissolution, winding up, and termination of members whose preferential rights are superior to those of persons receiving the distribution.
An action to enforce an obligation to return a distribution must be brought within 4 years after the distribution is made. Corp C §17704.06(e). Creditors have a right to enforce the obligations of members to return improper distributions. See §6.32.
NOTE: Even if a member is not obligated under Corp C §17704.06 to return an LLC distribution, a member may nevertheless be liable to return it under the California Civil Code provisions relating to fraudulent transfers (CC §§3439–3439.12) if the distribution left the LLC with unreasonably small capital. See CC §3439.04.
For further discussion of LLC distributions, see §§6.53–6.58.
§6.34 e. After Dissolution
Members of a dissolved LLC are subject to liability for causes of action against the dissolved company whether the cause of action arose before or after the dissolution of the company. A member’s liability is limited to the company assets distributed to the member on dissolution. However, it is not limited to the member’s prorata share of the claim. Corp C §17707.07(a)(1).
If the amount of distributed assets that a member is required to return exceeds the sum of that member’s prorata share of the claim and the amount for which the member could otherwise be held liable under the California Revised Uniform Limited Liability Company Act (RULLCA) for receiving an improper distribution, the member has the right to seek contribution for the excess from the other members or managers. See Corp C §17707.07(a)(1)(B).
Any action against a member of a dissolved LLC to return assets distributed on dissolution of the company must commence before the earlier of (Corp C §17707.07(a)(2))
The expiration of the statute of limitations applicable to the cause of action, or
Four years after the effective date of the dissolution of the LLC.
§6.35 2. Managers
No person who is a manager of an LLC will be personally liable under any court judgment or otherwise for any obligation of the LLC, whether that obligation arises in contract, tort, or otherwise, solely by reason of being a manager. Corp C §17703.04(a). This liability limitation is the same as the one provided in RULLCA for the benefit of members of an LLC. See Corp C §17703.04(a).
Corporations Code §17703.04(c) provides that nothing in Corp C §17703.04 shall be construed to affect the liability of a member to third parties for the member’s own participation in tortious conduct. RULLCA does not contain a similar provision with respect to the tort liability of managers or officers. Although this omission raises the question of whether the failure to include such a provision was intended to somehow limit the liability of managers and officers to third parties for their own tortious conduct, it seems unlikely that courts would read such a liability limitation into RULLCA. See, e.g., People v Pacific Landmark, LLC (2005) 129 CA4th 1203 (LLC’s manager was subject to personal liability for participating in criminal activity while performing his managerial duties; LLC had leased premises to an illegal business and allowed it to persist; court held that manager was not insulated from liability by virtue of prior Corp C §17158(a) for his personal involvement in aiding and abetting public nuisance and for failing to abate it, which forced city to bring red light abatement action).
As protection for a member or manager against such personal liability, the articles of organization or operating agreement may provide for indemnification as discussed in §6.42. In addition, the operating agreement may eliminate or limit a member or manager’s liability to the LLC and members for money damages, except for the following (Corp C §17701.10(g)):
Breach of the duty of loyalty,
A financial benefit received by the member or manager to which the member or manager is not entitled,
A member’s liability for excess distributions,
Intentional infliction of harm on the LLC or a member, and
An intentional violation of criminal law.
B. Other Sources of Liability
General rule: Managers and members not personally liable. In general, the formation of an LLC protects its managers and members from personal liability for debts, obligations, or other liabilities of the LLC, whether arising in contract, tort, or otherwise, solely by reason of being a member or manager (or both). Corp C §17703.04(a).
Personal liability by contract. RULLCA expressly permits the articles of organization or written operating agreement to provide that a member will be personally liable for any or all of the debts, obligations, or liabilities of the LLC, but requires that any such provision imposing personal liability specifically reference Corp C §17703.04(e). See Corp C §17703.04(e). To minimize the possibility of a manager or member being held personally liable for LLC obligations, any provision in the articles of organization or operating agreement imposing liability on a manager or member should be removed or narrowly drafted, and all separate agreements signed by a manager or member should be reviewed to make certain that a manager or member signing in a representative capacity does not unintentionally create personal liability.
Effect of certificate of cancellation. An LLC that has filed a certificate of cancellation will continue to exist for the purpose of winding up the affairs of the LLC, prosecuting and defending actions by or against it in order to collect and discharge obligations, disposing of and conveying its property, and collecting and dividing its assets. See Corp C §17707.06(a); DD Hair Lounge, LLC v State Farm Gen. Ins. Co. (2018) 20 CA5th 1238, 1243. Corporations Code §17707.08(b)(i) states that a certificate of cancellation is to be filed on completion of the winding up of affairs in accordance with Corp C §17707.06. Corporations Code §17707.08(c) states that, on filing a certificate of cancellation, an LLC is cancelled and its “powers,” rights, and privileges shall “cease.” The ambiguity among the certificate of dissolution, the certificate of cancellation, and the applicable authority of the manager is likely to be addressed in future legistation. Pending that correction, some commentators have noted a possible loss of liability protection for actions occurring after the filing of a certificate of cancellation. However, the language of Corp C §17707.06(a) expressly authorizes continued actions by the LLC. See DD Hair Lounge, LLC v State Farm Gen. Ins. Co., supra.
Other sources of liability. A member or manager of an LLC may also be personally liable for the LLC’s acts as a result of the following:
Prohibited distributions made to that member in violation of Corp C §17704.05 or §17707.05 that can be challenged by the LLC’s creditors (see §§6.33–6.34);
Distributions in violation of Corp C §17704.05 to which the member of a member-managed LLC or manager of a manager-managed LLC consented (see Corp C §17704.06(a)), unless the member is a member of a member-managed LLC in which the operating agreement expressly relieves the member of the authority and responsibility to consent to distributions and imposes that authority and responsibility in one or more other members (see §6.33);
Breach of any of the fiduciary duties of care or loyalty or the obligation of good faith and fair dealing (see §§6.36–6.40);
Participation in tortious conduct (Corp C §17703.04(c)) (see §6.24);
A written guaranty or other contractual obligation entered into by the member, other than an operating agreement (Corp C §17703.04(c)) (see §6.24);
Conspiring with another party, or aiding and abetting another party, in a breach of a fiduciary duty or tortious conduct (see, e.g., American Master Lease LLC v Idanta Partners, Ltd. (2014) 225 CA4th 1451, modified (May 27, 2014, B244689) 2014 Cal App Lexis 460); or
Failure to pay withholding taxes (see §13.11).
C. Steps to Minimize Liability
To minimize the possibility of personal liability being imposed on a member or members for acts of the LLC, counsel should observe the following precautions:
All operating formalities specified in the operating agreement or articles of organization should be respected. Although LLCs are not required to hold meetings (see §13.20), if the operating agreement provides for them, a minute book should be maintained, with properly executed minutes or written consents for all meetings of members or managers. The minutes should reflect compliance with all necessary approval requirements by the members or managers.
The LLC should be adequately capitalized to pursue the business activities in which it is engaged or proposes to engage, including anticipated liabilities. Proper records should be maintained as evidence of the adequacy of capitalization. The LLC should also obtain adequate insurance as protection against unanticipated liabilities.
All transactions between the LLC and its owners, both during its operations and while winding up the LLC (see Corp C §§17704.09–17707.06(a)), should be fully disclosed to all members and should be fair to the LLC, and informed consent should be obtained when appropriate (see §§6.36–6.40).
The status of the LLC as a separate legal entity should be respected in all its operations. The LLC’s funds should not be commingled with the funds of its members, managers, or any third party. The LLC should have its own separate bank account. In addition, separate financial books and records for the LLC should be maintained that are distinct from those of members, managers, or any other entity.
The LLC should conduct all business in its own name, not in the individual name of any manager or member. To ensure that third parties are not confused in their dealings with the LLC:
Letterhead, bills, invoices, and other business forms used by the LLC should show its full legal name (or fictitious business name), address, and telephone number(s).
The LLC’s telephone number(s) should be listed under its full legal or fictitious business name in all phone and business directories.
The LLC’s full legal or fictitious business name should appear on all LLC signs or advertisements, including signs at its principal place of business. Employee business cards should also show the LLC name.
Contracts should be entered into in the LLC’s name and executed with signature blocks that clearly identify the signing party as an agent of the LLC.
The LLC should be properly qualified to do business in each state in which registration is required.
If the operating agreement is to include a provision personally obligating any member for any debts, obligations, or liabilities of the LLC, the provision should be carefully drafted to specify and limit, if appropriate, these liabilities and to specify which member or members personally will be liable.
If the consent of a third party is required for any actions of the LLC, the operating agreement should be carefully drafted to delineate the requirements.