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How Does an LLC Protect You in a Lawsuit?

how does an llc protect you in a lawsuit

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Are you thinking of starting a side hustle for some extra income? Then it’s recommended that you start a limited liability company (LLC).

Even if you’re hanging up your 9-to-5 hat and trading it in for entrepreneurship, we’d recommend starting an LLC. This is because it’d provide you limited liability, meaning a separation between your personal finances and the company’s. For instance, if anyone ever tries to sue your business, then you won’t have to worry as much as if you’d chosen other legal structures.

How does an LLC protect you in a lawsuit? Read on to find out.

How Does an LLC Protect You in a Lawsuit?

Earlier in the introduction, we mentioned that LLCs provide limited liability (which is actually the biggest benefit of this business structure). But what does that mean for you exactly?

Having an LLC means it limits the personal liability of the owners (you and any other LLC members). Should your LLC be sued or face debts, creditors typically can’t pursue your personal assets. This means that things like your home, savings, or investments are generally protected from being used to satisfy business debts or legal judgments against the LLC.

If you decide at any time that you’d like to form an LLC, then use our business registration service. We can advise you on the best business structure for your situation, which may or may not be an LLC.

So how does an LLC protect you? Below are some additional details you should know.

An LLC is considered a separate legal entity from its owners. This separation means that the LLC can enter into contracts. It can also own property, and incur debts in its own name.

Consequently, any legal action taken against the LLC is typically directed at the assets of the business rather than the personal assets of its owners.

Check Operating Agreements

LLCs usually have operating agreements, which outline the structure and operation of the business. This agreement can further solidify the limited liability protection by clearly defining the rights and responsibilities of the members, as well as the procedures for handling legal matters and disputes within the company.

Exceptions to Limited Liability

Does an LLC protect your personal assets? Yes, in most cases, as there’s a separation between business and personal assets. However, LLC protection only goes so far, and there are some exceptions to limited liability.

Here are the main exceptions you should be aware of.

Commingling of Funds

If you mix personal and business finances, it can erode the separation between your personal assets and those of the LLC. This is known as “commingling of funds,” and it can potentially expose you to the liabilities of the business.

To maintain limited liability protection, it’s crucial to keep your personal and business finances separate. You should maintain distinct bank accounts and financial records for the LLC.

Fraudulent or Illegal Activities

If the LLC engages in fraudulent or illegal activities, courts may disregard the limited liability protection and hold individual members personally liable for damages. Engaging in fraudulent behavior (such as misrepresenting financial information or knowingly violating laws or regulations) can pierce the corporate veil and expose members to personal liability.

Failure to comply with requirements can jeopardize the limited liability protection of the LLC. Examples include not filing necessary documents with the state, paying taxes, or maintaining proper licenses and permits.

It’s essential to stay current with legal obligations to ensure the continued protection of your personal assets.

Personal Guarantees

In some cases, lenders or creditors may require personal guarantees from LLC members to secure loans or credit lines. If you sign a personal guarantee, you’re essentially agreeing to be personally liable for the debt if the LLC defaults.

While personal guarantees may be necessary to obtain financing, they expose your personal assets to risks beyond the protection of the LLC. So if you’re planning on doing this, tread carefully.

Negligence or Professional Malpractice

If an LLC member personally commits acts of negligence or professional malpractice while acting on behalf of the company, they may be held personally liable for resulting damages. For example, if a member of an LLC law firm is found guilty of malpractice, they could be personally liable for any resulting lawsuits, even if the LLC itself is sued.

Extra Steps You Can Take to Ensure Protection

The above section may be scary to read. However, there are many things you can do to ensure limited liability is present. One is to keep your business and personal finances separate to prevent alter ego claims.

Follow these steps so that if your LLC is sued, you won’t have to worry.

Get Liability Insurance

General liability insurance isn’t required in order to run an LLC. However, many vendors and clients may want to see that you carry an activity policy before working with you, so it’s in your best interest to have one.

More importantly, this insurance will protect both the LLC’s assets and your own. It can mean the difference between your business staying open or shutting down.

Eliminate Personally Guaranteed Debts ASAP

It’s likely that you personally guaranteed a loan to get your business off the ground. This is fine, but it’s best if you eliminate this debt as soon as you can. You have two options here: you can either pay off the loan completely or refinance it.

On that note, you shouldn’t keep too much money in your LLC. These funds can be used to satisfy judgments against the company, so to avoid this, you should distribute the money as profits to the LLC members or reinvest in the LLC.

Keep Your Assets Safe

How does an LLC protect you in a lawsuit? The main way is by separating your business and personal assets.

This doesn’t mean that you’re completely safeguarded though. But by being compliant, eliminating personally guaranteed debts, having a good liability insurance policy, and redistributing LLC profits, you’ll have fewer worries.

If you’re sold on the idea of an LLC, then sign up with Busines Anywhere now. Have a business up and running within minutes, in any state you wish.

About Author

Picture of Rick Mak

Rick Mak

Rick Mak is a 30-year veteran businessman, having started, bought, and/or sold more than a dozen companies. He has bachelor's degrees in International Business, Finance, and Economics, with masters in both Entrepreneurship and International Law. He has spoken at hundreds of conferences around the world during his career on entrepreneurship, international tax law, asset protection, and company structure. Business Anywhere Editorial Guidelines

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