Exceptions to the LLC Personal Liability Shield
A primary reason to set up an LLC (limited liability company) is to shield a business owner from personal liability for the debts, obligations and liabilities of the business. This protection, however, is not absolute. Some notable exceptions to the LLC personal liability shield are discussed below.
LLC Personal Liability Shield
The LLC personal liability shield for owners (called its “members”) is contained in Section 22 of the Massachusetts Limited Liability Company Act, M.G.L. 156C (the “Act”):
Except as otherwise provided by this chapter, the debts, obligations and liabilities of a limited liability company, whether arising in contract, tort or otherwise, shall be solely the debts, obligations and liabilities of the limited liability company; and no member or manager of a limited liability company shall be personally liable, directly or indirectly, including, without limitation, by way of indemnification, contribution, assessment or otherwise, for any such debt, obligation or liability of the limited liability company solely by reason of being a member or acting as a manager of the limited liability company.
M.G.L. 156C, Section 22. (emphasis added).
Members are further protected under the Act when they rely in good faith on provisions of the operating agreement, the records of the LLC, and information and reports of the managers,members and others with professional expertise who have been selected with reasonable care by or on behalf of the LLC. See id. at Section 11, 63(b).
But the plain language of section 22 allows for two exceptions to this shield. First, the LLC personal liability shield is explicitly subject to exceptions contained in the LLC Act. See id. at Section 22. (“Except as otherwise provided by this chapter”). By implication, this means that the LLC Act contains exceptions to the personal liability shield which need to be taken into account. Second, the LLC personal liability shield under the LLC Act is expressly limited to shielding the member from potential debts/liability “solely by reason of being a member or acting as a manager.” Id. (italics added). As a result, the shield does not work protect a member from being held liable for his/her own tortious conduct or personal debts/guarantees/
Additionally, exceptions to the LLC personal liability shield are created by other statutes and by the judicially created equitable doctrine of piercing the corporate veil. These exceptions will be discussed in more detail below.
LLC Act Exceptions
There are two notable exceptions to the LLC personal liability shield under the Act.
Under the Act, a member can be personally liable to the LLC for promised but unpaid contributions. See id at Section 28. So if a member promises to contribute a certain amount of money, but fails to provide it, he/she can be held personally liable. The member can also be personally liable to creditors who extended credit in reliance on the member’s promised contributions. See id.
Distributions Violating the Operating Agreement
A member who votes for or assents to a distribution that violates the LLC’s operating agreement can also be personally liable to the LLC for the amount of the distribution that exceeds the amount permitted. See id. at Section 35. The member can also be liable to a creditor for improper distributions if the creditor extended credit in reliance on the operating agreement. But members that are found liable under this section may seek contribution from other culpable members who knew that the distribution violated the operating agreement. Id.
These LLC Act exceptions result from default provisions under the LLC Act. The risks can be minimized by a carefully drafted operating agreement, so consult with a knowledgeable LLC lawyer for help .
Other Statutory Exceptions
Other federal and state statutes also create exceptions to the LLC personal liability shield, especially for LLC members that are managers and actively participate in the business.
One notable exception at the federal level is for members and managers who are “responsible persons” under I.R.C. § 6672. These individuals can be held personally liable for withholding payroll taxes from their employees and not paying these taxes to the government. See, e.g. https://www.irs.gov/pub/irs-pdf/n784.pdf.
At the state level, members and managers can be personally liable under the Massachusetts Wage Act, M.G.L. c. 149 §§ 148-150. See Cooke v. Patient Edu, LLC, 465 Mass. 548, 549 (2013) (concluding that manager who “controls, directs, and participates to a substantial degree in formulating and determining” the financial policy of an LLC can be personally liable for Massachusetts Wage Act violations); Segal v. Genitrix, LLC, 478 Mass 551,552 (2017) (LLC members can be personally liable under Massachusetts Wage Act when they are “officers or agents having the management” of the company).
These two statutory exceptions are not exhaustive and there may be others depending on the circumstances of your business. For example, if your Massachusetts LLC has New York employees, the top 10 members are potentially liable for violations of New York’s wage and hour laws under legislation, that goes into effect on February 10, 2020.
Many of these risks can be reduced by complying with the appropriate statutes and by purchasing appropriate insurance (if you can afford it). The operating agreement for your LLC should also have appropriate indemnification provisions so that the LLC indemnifies members and managers to the fullest extent under the LLC Act. So, consult with a knowledgeable business attorney for help.
Member’s Personal Debts/Obligations/Torts
Another class of exceptions to the LLC personal liability shield are the debts,obligations, and torts of a member apart from his/her role in the LLC. For example if a member has a personal credit card, then he/she is still responsible for making credit card payments. Similarly, if a member engages in tortious conduct outside of the LLC, he/she can still be personally liable for this conduct.
However, some personal debts, obligations and torts can occur while a member is acting on behalf of the LLC.
Member’s Personal Guarantees
Third parties, such as banks or commercial landlords, often ask members of smaller LLC’s to provide personal guarantees in connection with a loan or commercial lease. From the third parties’ perspective, the member’s personal guarantee provides further assurance of payment in case the business fails. But a personal guarantee creates a serious risk of personal liability for the member, especially if the business fails or otherwise breaches the contract.
Members often acquiesce to these requests because they are unaware of the language or do not have the bargaining power to avoid a personal guarantee. But it may not hurt to try. Consult with a business contract attorney for help with these contracts and see if these requests for personal guarantees can be removed.
Signature Blocks on LLC Contracts
Another possible exception to the LLC personal liability shield occurs when a member/manager signs an LLC contract, but does not sign it properly! For every LLC, best practices dictate that the signature block for every LLC contract signed by a manager should be as follows:
Jane Doe, Manager.
A signature block like the above makes it clear that the LLC is signing the contract and that Jane Doe is signing in her capacity as manager of the LLC and not personally.
Unfortunately, many LLC managers or members will sign an LLC contract with the following signature block:
Jane Doe for XYZ, LLC
This signature block leaves open the possibility that Jane Doe is signing the contract in her personal capacity and could be held liable for any breaches of the contract. Changing it to to “Jane Doe as manager for XYZ, LLC is not much better.
This risk is simple to reduce or eliminate. Make sure that all LLC contracts have signature blocks that clearly identify the LLC as the party signing the contract! Doing so will reduce the risk of personal liability for the manager or member who actually signs the contract on behalf of the LLC.
Member’s Tortious Conduct
Another possible exception to the LLC personal liability shield is when a member or manager personally engages in tortious conduct while acting on behalf of the the LLC or in connection with his/her duties for the LLC. See e.g. Commonwealth v. Tradition (North American) Inc., 91 Mass. App. Ct. 63, 75 (2017) (“officers and employees of an [LLC] … are liable for torts in which they personally participated.”); Pointer v. Castillani, 455 Mass. 537 (2009) (affirming judgement for breach of fiduciary duty by member).
However, this potential for a member’s personal liability can be significantly reduced under the LLC Act. With limited exceptions, members and managers can be indemnified by the LLC for most tortious acts. See M.G.L. 156C, Section 8. And the LLC Act also permits the LLC’s operating agreement to limit or eliminate the fiduciary duties owed to other members and the LLC. Id.
Be careful! Provisions regarding indemnification or fiduciary duties need careful drafting, so consult with a knowledgeable LLC lawyer for help. And, of course, if you can afford it, purchase appropriate business insurance.
Piercing the Corporate Veil
Finally, the last significant exception to the LLC personal liability shield is the equitable doctrine of piercing the the corporate veil. Massachusetts courts apply this doctrine to ignore corporate formalities and find owners personally liable for a corporation’s debts and liabilities when:
- There is active and pervasive control of related business entities by the same controlling persons and there is a fraudulent or injurious consequence by reason of the relationship among those business entities.
- There is “a confused intermingling of activity of two or more corporations engaged in a common enterprise with substantial disregard of the separate nature of the corporate entities, or serious ambiguity about the manner and capacity in which the various corporations and their respective representatives are acting”.
Courts weigh twelve factors to decide whether to pierce the corporate veil and consider whether there exists:
- Common ownership;
- Pervasive control;
- Confused intermingling of business activity assets, or management;
- Thin capitalization;
- Nonobservance of corporate formalities;
- Absence of corporate records;
- No payment of dividends;
- Insolvency at the time of the litigated transaction;
- Siphoning away of corporate assets by the dominant shareholders;
- Non functioning of officers and directors;
- Use of the corporation for transactions of the dominant shareholders; and
- Use of the corporation in promoting fraud.
Id. at 733 (citation omitted).
Massachusetts courts will likely consider the same factors and pierce the LLC form in appropriate circumstances to find members personally liable See, e.g., Retirement Systems v. Assessors of Billerica, 453 Mass. 495, 504 (2009) (“Although the doctrine [of piercing the corporate veil] applies to corporations, we see no reason why it should not also apply to limited liability companies”); Kosanovich v. 80 Worcester St. Assocs., LLC, 2014 Mass. App. Div. 93, 95 (2014) (affirming veil piercing and finding sole member personally liable when member had “pervasive control” and failed to properly maintain corporate records).
A full discussion of these factors is beyond the scope of this blog post. But all are important and an LLC should strive to avoid failing in any area to reduce the risk of personal liability for its members. If you are concerned, consult with a knowledgeable business attorney to discuss your options.