Will an LLC Protect Me if I’m Sued?

QUESTION:

Will an LLC protect me if I’m sued?

ANSWER:

Yes. And that’s exactly why you should avoid transacting business without having a properly structured LLC in place.

Here are situations an LLC can help protect your personal assets (i.e. primary home, secondary homes, personal art collections, etc.):

A creditor obtains a unsatisfied judgment against the LLC.
A bankruptcy trustee seeks money by taking possession of your business partner’s ownership interest if the partner files for personal bankruptcy.
A former spouse seeks your business partner’s ownership interest in a divorce settlement.

In these situations, the frustrated party would ask a court to transfer your business partner’s ownership interests to them. Under corporation law, you could end up in business with your business partner’s former spouse or personal creditor (not the ideal situation). An LLC can stop this from happening.

LLC statutes afford LLC owners three main asset protection vehicles: (1) limit liability protection; (2) “pick-your-partner”; and (3) charging order provisions.

Limited Liability.

In theory, the LLC remains solely liable for any claims brought against the LLC or any debts or obligations of the LLC. The members and managers are not personally liable for such claims, debts, or obligations. In short, the limited liability protections help safeguard your personal assets from claims brought by third parties against the LLC.

Importantly, the LLC remains 100% liable for all claims brought against the LLC and all the LLC’s business assets are at risk with such claims. Therefore, many of our clients will form multiple LLCs, sometimes structured as subsidiaries or sister companies, to isolate the liabilities of one LLC from the others. A restaurant group, for example, that owns multiple restaurant locations will often create a new LLC for each location. If one location becomes liable, then in theory, that liability does not extend to the other LLCs. We say “in theory” because it depends on how well you have structured the intercompany agreements, the sharing of resources and other business functions. Additionally, make sure you insure your LLC against claims by purchasing the proper business insurance.

Pick-your-partner.

As implied by the term, you cannot force an LLC owner to be in business with someone else (i.e. a creditor). Under most LLC Acts, an LLC owner has the right to pick her partner. This provision recognizes the success of any business venture depends on compatibility. Accordingly, although your business partner can freely transfer her economic rights, she cannot transfer her management rights without the consent of all other members. This prohibition extends to the courts. Thus, a court cannot order your business partner to transfer her management rights to a third party. This prevents you from being in business with a former spouse or a personal creditor.

Charging Order provisions. A charging order provision protects the LLC’s business assets if a creditor obtains an unsatisfied judgement against your business partner. The provision limits the creditors recourse to that business partner’s economic rights, without impacting the economic rights of the other owners.

Here is an example. Your business partner defaults on a payment obligation. As a result, a personal creditor obtains an unsatisfied judgment against your business partner. Under most LLC Acts, the creditor can ask the court for a “charging order” against your business partner. If granted, the charging order would allow the creditor to receive your business partner’s right to profit distributions. Rather than the LLC distributing those profits to your business partner, the LLC would distribute the profits to the creditor to pay down your partner’s unsatisfied judgment. In many states, a charging order is the only legal mechanism for a creditor to gain access to LLC distributions. The LLC Act prevents creditors from levying LLC assets to satisfy judgments. This means a creditor cannot foreclose on LLC assets (i.e. sell LLC property at a public auction) to generate cash to pay down your business partner’s personal judgment. If the creditor could levy LLC assets, then this would impact your investment and economic interests in the LLC. And yet, this is exactly what a creditor can do under general corporation law. Forming an LLC ensures your indirect interest in the LLC assets remain protected.

If you want to scale fast and with confidence, call our office at 770-282-8967 and schedule a Strategy Session. You can also reach out to us at info@inprimelegal.com. During our time together, we’ll collaborate on how to align our legal strategy with your business goals to help you achieve more in business.

Jonathan Page

Chief Visionary

“Litigate less, scale bigger, and experience the InPrime advantage!”