As a lawyer who helps start-up companies, I’m often asked whether forming a limited liability company (LLC) will truly shield a company’s owner(s) from the risk of incurring personal liability. Sometimes, my clients are surprised to find out that the answer is no – forming an LLC only serves to limit personal liability with respect to the business in a few very specific, albeit important, ways.
Although LLCs get their name from the fact that an owner’s personal liability is limited with respect to the business, that limitation applies mainly to liability for business obligations. For example, it’s true that the owner of an LLC will generally not be liable for the company’s debts or contractual obligations beyond his or her investment in the company. If the company fails altogether or defaults on a specific obligation, creditors will not usually be able to reach the business owner’s personal assets. In this sense, forming an LLC is often a good partial strategy for managing the most fundamental risk associated with owning a business – that it could ultimately fail.
However, business owners should be aware that forming an LLC will not necessarily protect the owner from liability related to personal injury or other harms caused by business activities. Although ownership by itself generally will not render the LLC’s owner(s) personally liable for these harms, the mere fact that the LLC exists does not always shield the owner from personal liability if the owner is personally involved with the activity that causes injury. For example: if the owner of an LLC drives a company car to a business meeting and negligently causes an accident along the way, both the business and the owner are likely to be liable. The owner won’t be able to claim that the LLC’s existence absolves him or her from personal liability because the owner was personally negligent in his/her operation of the company car. The injured party will likely sue both the company and LLC owner for damages.
Although oversimplified, one lesson to be learned from this example is that an LLC owner will often remain personally liable for his or her own acts that cause injury, even if those acts are performed in the course of the LLC’s business. As such, it’s important for an entrepreneur to thoroughly consider what risks are inherent to his or her business as well as what his or her personal relationship to those activities will be. Even if the owner plans to have no direct involvement with business activities that carry obvious risks of third-party injury, there will still likely be some residual risk of personal liability, particularly for start-ups that often rely on its owners to wear many different hats. There are a number of ways that these residual risks can be mitigated. Two that often prove useful are for the company to maintain adequate liability insurance and to ensure that the company’s operating agreement adequately addresses when and how the company will indemnify owners for personal liability incurred in the course of business. Each business has a unique risk profile and it can often be helpful to work through these issues with an experienced attorney in order to ensure that the company’s governing documents include appropriate safeguards regarding the apportionment of liability.
Perkins Thompson regularly helps entrepreneurs and start-up companies navigate the complex legal issues that arise during a company’s formation and early growth stages. If you would like more information please email Ian Green or call him at 207-400-8176.