Tuesday, October 21, 2008

Personal Liability for LLC Debts

It's a common question from LLC members and, in these troubled financial times, the issue shall become even bigger. The general rule for member liability upon LLC debt is set forth in the LLC act of the state where your LLC was organized. California's Corporate Code Section 17101 is typical of what one finds in other states.
Except as otherwise provided in Section 17254 or in subdivision (e), no member of a limited liability company shall be personally liable under any judgment of a court, or in any other manner, for any debt, obligation, or liability of the limited liability company, whether that liability or obligation arises in contract, tort, or otherwise, solely by reason of being a member of the limited liability company.
I've reproduced just subdivision (a) of section 17101. Subdivision (e) basically states that the general rule of no member personal liability found in (a) is inapplicable where the member cosigns or guarantees an LLC debt. A new small business entity, whether it be an LLC or Sub S corporation, has by its nature zero credit history. As such, the owners invariably are asked to cosign business contracts such real estate leases, bank lines of credit, credit card accounts, equipment leases, and phone service contracts. Even if your LLC has been in business for a number of years, you as a founding member could still be liable for LLC debts from these sorts of accounts that were set up years ago but for which you cosigned. If your LLC is in danger of going under and you are concerned about personal liability, check the contracts with the lenders / suppliers. I've seen instances where the members cosigned on a contract exposing themselves to personal liability without even realizing they had done so.

Sections 17254 and 17255
California does not give titles to their statutes. If they did, Section 17254 would be named "Liability for unlawful distributions". See Section 407 of the Uniform Limited Liability Act. Essentially, Sections 17254 and 17255 make a member who votes for distributions to the members personally liable where said distribution will leave the LLC unable to pay its debts or with liabilities in excess of assets. The comments to Uniform LLC Section 407 state: "The recovery remedy under this section extends only to the company, not the company's creditors." California section 17254 is close to the model provision but not exactly the same. I'm uncertain whether a creditor may attempt to use Section 17254 to force personal liability upon members who have violated its provisions. Under the model act, only the LLC could make a claim against a member for violation of Section 407. Be that as it may, creditors also have resort to the Uniform Fraudulent Conveyances Act for transfers made at a time when a debtor is insolvent for less than full and fair consideration.

In light of these provisions, members need to be very careful about making distributions from the LLC to themselves when the LLC could be considered insolvent or otherwise unable to pay its debts.

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