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When business owners form a limited liability company (LLC) in California, they generally do so with the expectation that their personal assets will be shielded from the company’s liabilities. However, there are important exceptions that every business owner should know. These exceptions could expose members and managers to personal liability under certain circumstances. This blog will explore these exceptions and provide tips to protect yourself from potential risks. 
What Is LLC Member Liability?
In California, forming an LLC typically protects its members and managers from personal responsibility for the company’s debts and obligations. This protection is outlined in the California Corporations Code (Section 17703.04). However, there are notable exceptions, such as applying the alter ego liability rule. If the LLC operates in a way that disregards its separate legal identity—mixing personal and business assets or failing to keep proper records—members can be held personally accountable.
Alter Ego Liability: The Exception to the Rule
The concept of alter ego liability means that, under certain conditions, courts can “pierce the corporate veil” and hold LLC members responsible for company debts. This can happen if the LLC is found to be operating in bad faith, such as through fraudulent transfers of assets or failure to follow basic formalities.
In the case of Mesler v. Bragg Mgmt. Co. (1985), the California Supreme Court established that the same rules for corporate shareholders apply to LLC members when alter ego liability is concerned. This means that members could face personal lawsuits if the LLC misbehaves.
Other Sources of Personal Liability
In addition to alter ego liability, LLC members could face personal liability under several other circumstances:
- Prohibited distributions: If members receive distributions in violation of the Corporations Code, creditors could seek personal compensation.
- Breach of fiduciary duties: Members owe the LLC a duty of loyalty and care. If a member violates these duties, they may face personal legal consequences.
- Tortious conduct: Engaging in or aiding illegal activities could result in personal lawsuits, even if done through the LLC.
Steps to Protect Yourself as an LLC Member
Although the potential for personal liability exists, there are steps you can take to minimize risk:
- Maintain formalities: Keep minutes of meetings, follow the operating agreement, and document major decisions.
- Separate personal and business assets: Ensure the LLC has its own bank accounts and does not mix personal finances with company funds.
- Adequate capitalization: Make sure your LLC is financially stable and has sufficient insurance coverage.
- Use clear contracts: Always sign contracts as an agent of the LLC, not in your personal capacity.
While forming an LLC in California offers strong protection against personal liability, it is essential to understand the exceptions that could put your assets at risk. By following the guidelines above, you can safeguard your personal wealth and minimize potential liabilities.
If you are unsure about your LLC’s compliance or facing legal challenges, it’s crucial to consult with an experienced business litigation attorney. Schedule a consultation today with our law firm to ensure your LLC operates within the law and protects your assets.
