Do You Have an LLC or Corporation in Illinois? You May Not Be Protected

Do You Have an LLC or Corporation in Illinois? You May Not Be Protected

office view, business attorneyForming an LLC or a corporation protects members, investors, and their personal and family assets from liability for claims of business creditors, but the protection is not bulletproof. In some situations, personal liability for the obligations of LLCs and corporations may still exist.

The Value of Limited Liability

Limited liability companies and corporations shield business owners from personal liability in most situations if the business becomes liable to a third-party. Sole proprietors and the general partners in a general or limited liability partnership are all subject to unlimited liability if a business is sued. Their personal assets could be seized to satisfy claims. Limited liability entities – like LLCs and corporations –  provide a corporate veil to ensure that the personal finances and assets of the corporate principals are not exposed to a lawsuit in most situations.

Types of Liability

There are two main types of liability that should be considered.

    1. Tort Liability: Tort liability refers to liability for damages that result from tortious conduct committed by the company through its employees or agents. Damages caused by the failure to provide an ordinary level of care to the injured party are an example of tort liability. For business owners, the classic example is premises liability (i.e. “slip and fall”) for retail locations open to the public and intentional torts for bars and clubs (bouncers forcibly removing patrons).
    2. Contractual Liability: When a promise is made to do something for another party, contractual liability is incurred. A contract is the bargained-for-exchange of goods or services between one or more parties. When a service contract or bank loan is initiated, contractual liability is formed. For protection against personal liability, contracts should be entered in the name of, or as the agent of the entity as often as possible.

Potential Liability

The purpose of an LLC or corporation is to act as a personal liability shield. However, that liability shield is not invulnerable – it can be pierced and personal assets can become vulnerable.

For example, business owners that participate in tortious conduct can be held liable for their own actions because the culprit can almost always be named as a defendant in a tort liability case. In practice, the plaintiff will likely focus collection efforts on the business under the presumption that the business has more assets.

Another common example is when business owners use their personal assets to pay for LLC obligations and those payments do not go through. For example, when a business owner pays for an LLC contractual obligation with a personal check and that check bounces, the business owner can be liable for the bounced check.

Piercing the Corporate Veil

Piercing the corporate veil is a legal technique by which a plaintiff can “pierce” through the limited liability shield of a corporation or LLC. Although few Illinois state cases are examining the issue of piercing LLC liability shields, it is still reasonable to presume that piercing is a real possibility. To “piece the veil,” the plaintiff must prove that there was a unity of interest between the owner and business and that circumstances exist which illustrate that there is no meaningful difference between the personal affairs of the owner and the operation of the business.

In practice, this means the business owner comingles his personal finances and the LLCs, the owner fails to observe corporate formalities (e.g., quarterly meetings, taking a salary, and paying payroll taxes), the LLC isn’t adequately capitalized (i.e., the business doesn’t have enough cash or assets to reasonably pay for its debts and expenses), pay debts before making distributions to owners, issue certificates, and follow the terms of the operating agreement.

Steps to Maintain the Corporate Shield

Business owners can protect themselves by observing corporate formalities. For example, owners should capitalize their companies with enough cash and assets to reasonably operate and pay debts. There isn’t a bright-line rule; it depends on the nature of the business. Moreover, owners should have regular member meetings, take minutes, and certify ongoing business operations.

One of the number one ways LLCs lose their shield is when owners commingle their personal and business assets. Owners should not use business accounts to settle personal obligations. LLCs also should pay distributions pursuant to the terms of the operating agreement and only until after debts are satisfied. Owners should also exercise oversight over the officers, and that oversight should be recorded in the meeting minutes. The LLC should adhere to standard accounting practices.

For another layer of protection, business owners can purchase liability insurance. Business insurance can provide coverage for general liability, errors and omissions, and other issues. Having liability insurance also helps ensure that money is available to defend or pay claims.

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