Does an LLC Protect Me Against Personal Liability
As a property management company in Fayetteville, NC, we get this question a lot, and like everything, it depends.
While it is not absolutely necessary to form an LLC for your investment property, we recommend our clients form an LLC under certain circumstances.
Accidental Landlord vs Property Investor and LLC Personal Liability Protection
There are generally two broad classes of investors for whom we manage properties in Fayetteville. The accidental landlords who only own one property, and have PCS’d from the Fayetteville area, and the real estate investor who bought a property for the specific purpose of real estate investment.
While the latter is a more common phrase, many landlords are not familiar with what an accidental landlord is. To put it succinctly, an accidental landlord is one who didn’t consider renting their property before, but for some reason , commonly inability to sell, they end up as a landlord.
Usually, it is not necessary for the accidental landlord to form an LLC. This is because, as you will read below, the accidental landlord, or single homeowner, will generally not be afforded the many protections that the landlord believes they will have. Additionally, it is likely that the accidental landlord will not continue purchasing investment properties in the future.
For the property investor, however, we always recommend you form an LLC, or some other corporate entity for your Fayetteville property. This is because, as a property investor, from day one, you should consider what they are doing as a business, and the necessary consequence of this mentality is business growth.
Does Forming an LLC Provide Blanket Personal Liability Protection
While we would like to think that forming an LLC gives us blanket immunity when you manage our own properties, this is simply not the case.
As the name suggests, the Limited Liability Company has limited liability. It is not a get out of jail free card.
Having said that, our recommendation is always for the real estate investor to form an LLC to protect personal assets to the maximum degree possible. Although this is a case by case determination, and based upon the overall risk and exposure of the property investor, it is always a good idea.
With some important caveats!
What most property investors in Fayetteville, NC fail to understand is that even with a proper LLC formation, you can still be held liable. It’s actually not as straight forward as forming an LLC.
Moreover, there are other parts to the proper formation of a company which need to be understood. The LLC formation, by way of filing articles of incorporation with the state, isn’t enough. You must also take into account the ancillary documents such as the operating agreement.
All of these documents, along with some of the things discussed below, will be read in conjunction with one another, to determine if you may be held personally liable.
If you are a sole member LLC, and just starting out, much of the necessary work can be done by you. This includes the drafting of an operating agreement.
As you grow, either bringing on more partners or properties, you may want to consult with an attorney. This is where you truly want to gain the full benefit of your LLC’s legal protections.
Now let’s discuss a couple of considerations.
What Types of Personal Liability Must an LLC Consider
As a property investor, tort and contractual liability are two of the main liability categories you must consider.
Contractual liability, as the name suggests, is liability that is brought about a result of you doing something for another person.
As a property management company, we enter into contracts with landlords to perform certain duties. As a result, the contract is what governs whether or not we are liable, and may also include what will happen in the event we do not live up to our part of the bargain.
As a real estate investor, your major concern is probably how this relates to personal asset protection. In such light, your biggest contractual liability area is with funding for your property.
Tort liability, on the other hand, is liability that results from acts you commit against another person. Generally speaking, and without going down the legal rabbit hole, tort liability is premised upon you doing something negligently.
From a Fayetteville property manager perspective, we see tort liability when a landlord fails to make repairs, a tenant or guest is injured on the property, or the landlord fails to do certain things required by law.
While there is overlap between what is tort and what is contractual liability (especially when taking the lease into account), for your purposes, let’s just think about it like this: If it is a business that is injured, it’s contractual; if it’s a person/tenant, then it is tort.
What is Piercing the LLC’s Corporate Veil for Personal Liability
Piercing the corporate veil is an often thrown around term, with many having little idea what it actually means.
In the most simplest sense, piercing the corporate veil means that the court is going after you personally, and not just the LLC.
Piercing the LLC’s corporate veil refers to a situation where the court decides to ignore the LLC, and hold the officers and shareholders personally liable for the corporations actions or debts.
While each state has different thresholds when piercing the corporate veil of an LLC, generally speaking, courts will attempt not to find you personally liable, so long as your organizational forms and functions are in accordance with the law.
In other words, the more you act like and conduct yourself as an LLC, the less likely the court is to allow a creditor, or individual, from garnishing your personal assets.
The caveat to this is when the LLC is merely acting as your alter ego. What this essentially means is that the LLC is only a sham, and you are actually the business.
Below we will set forth some ways you can avoid your LLC being seen as an alter ego, and give you some best practices to truly make it a separate entity.
A Single Member LLC to Manage Your Property Increases your Personal Liability Exposure
Most investors, at the outset, are running everything solo. They serve all of the functions of the company structure, and wear multiple hats.
As a result of this, some the protections of a multi-member LLC are not provided to a single member LLC. This is especially true when it comes to charging orders. A charging order is when the court orders an LLC, among other things, to pay money owed from funds distributed to an owner of an LLC.
In the case of a single member LLC, because you own 100% of the company, and 100% of the distributions are to you, the LLC essentially has no protection against a charging order. Your personal liability is intertwined with the operations of the LLC.
Charging orders can give you a headache to attempt to understand, but the key point of them is that a judge can order payment for personal liability, through the LLC. In this case, your shares in the LLC are personal property, therefore, a judge can give a charging order to foreclose on those shares or distributions, as payment.
How Does Funding Play into Personal Liability for an LLC
You know the old phrase of following the money? You follow it until you get to the source. The same holds true in protecting your personal liability under your LLC.
A key consideration is: Is any money you borrowed guaranteed by you?
If it is, then you can be held personally liable for debts.
You will be held liable to lenders if you provided a personal guarantee of the funds. When you sign the personal guarantee, you are informing the bank that you are the party that is ultimately responsible for payment, even if the LLC fails.
This is why most banks won’t loan money to your LLC for property investment. They don’t want you to simply walk away with no skin in the game. Can you imagine the immense financial loss to banks if anyone could simply buy a home with an LLC, and be protected from personal liability?
It is not impossible to get a loan from a bank through your LLC, but it will require a fair deal of understanding how to build a business financial portfolio which will prompt a bank to underwrite your LLC’s business venture.
This is another reason why you want to build your business credit score separate from your personal credit. When you build up your business credit score, you get the advantage of personal liability protection from your LLC.
Can an LLC Protect Against Personal Liability for Actions of Co-Owners?
As we said earlier, you don’t receive the full benefit of personal liability protection when you are a single member LLC. In a multi-member LLC, however, you receive some personal liability protections that are well worth the time to invest in making sure your company is formed properly.
Generally speaking, all states provide personal liability protection for LLC members for any personal wrongdoing committed by co-owners. If the LLC is found liable for misconduct on the part of one of the owners or employees, then the LLC will be held liable.
The owners, on the other hand, will not be held personally liable. The caveat to this, however, is that the offending owner or employee could also be held personally liable.
Take for example a handyman, who is your employee not an independent contractor, drives drunk and crashes into a person walking down the street. In this case, the LLC would be liable, and the handyman would be personally liable. The injured person can sue your LLC, as well as personally sue the handyman, but you cannot be held personally liable for the conduct.
Make Sure Your LLC Is Completely Separate to Avoid Personal Liability
Making sure your LLC is completely separate. This includes having a separate bank account, the no brainer articles of incorporation as well as a operating agreement (even if there is only one member), and having a separate insurance policy for the LLC. All of these give weight to the fact that your LLC is a separate entity. We would even go so far as to advise having a separate address, telephone number and website for your business. Doesn’t have to be fancy, just get a presence that shows you are a business.
Now let’s discuss some ways you can make your LLC separate for personal liability purposes.
Sign All Documents in the Name of Your LLC
Sign all documents, and everything you send in the name of your LLC. The documents should clearly state that it is John Smith, CEO, Smith Investments, that is signing the documents, not John Smith who happens to be the CEO.
Decrease Personal Liability by Loaning Money to Your LLC
Don’t merely give money to your LLC, make it a loan. When I first started business 8 years ago, instead of just providing my own capital, I loaned my business $8,000. I drafted up a promissory note, and my business paid the debt back according to the schedule (albeit to myself).
Even though the money was coming from me personally, it was loaned to the company, and the company had an obligation to pay it back.
That money was then used to buy assets for use of the company, and those assets then became collateral against the loan.
Every dollar you give to the LLC should be loaned, with a payment schedule.
Keep Your LLC Bank Accounts Separate and Not Comingled For Personal Liability.
Going back to separate bank accounts, make sure your funds aren’t comingled, and you are being paid by your LLC. Comingling of funds occurs when your personal and business bank account are indistinguishable. The name of the bank account is immaterial.
Even if you have “Smith Investment Bank Account” as the name, if you are dipping in the account for personal matters, that’s comingling.
If you need to take money from the LLC, make sure it is transferred according to the operating agreement. In other words, your operating agreement should have a clause which sets forth owner distributions.
One of the pitfalls a lot of business owners make is not paying themselves from the LLC. If you aren’t paying yourself, and treating yourself as an employee/member of the LLC, this adds more weight to the fact that the LLC is merely your alter ego.
If you are unable to make a payment to yourself, or other members, in a particular month, this should be annotated in your meeting minutes. Yes. . . you have to hold meetings even if you are the sole member of the LLC.
Make Sure Your LLC’s Accounting is Up to Date
Money, money, money, and money again. We keep stressing the financial side of things because it is the area which will provide the greatest weight as to whether or not your business is separate.
Your accounting should reflect each and every dollar that has flowed in and out of the LLC. Receipts for purchases to distinguish business from personal, as well as documentation of payments and receipts from third parties, should all be accounted for.
It is imperative, again, that the paper trail shows you are not using the LLC for your personal benefit.
Get Insurance to Protect Your LLC and Decrease Personal Liability
Insurance can provide you with additional personal liability protection in three ways.
First, insurance will provide you with additional evidence that your LLC is separate from you. This doesn’t include merely having a standard homeowner’s insurance policy.
Insurance, in this case, means having the appropriate business insurance an operating company would have. A good policy will provide a signal that you are operating a legitimate business.
The second thing insurance will provide is a buffer against financial liability.
Assuming, for argument’s sake, you didn’t form an LLC, or formed it incorrectly. The coverage of the insurance policy might make it so the other party doesn’t need to go after you personally. In other words, the debt could be satisfied fully from the insurance coverage.
Last, the insurance policy should cover your legal fees. Legal fees, by far, are one of the most overlooked areas when it comes to investment property management and business formation.
As an afterthought, legal fees have the potential to devastate your financial position if not property taken into account.
A good insurance policy allows your LLC to be defended, while maintaining the piece of mind of knowing the costs are covered.
Final Thoughts on Decreasing Personal Liability with an LLC
As we said earlier, when and if you need an attorney to draft up the necessary documents for an LLC formation will be situation dependent.
Simple agreements with a sole owner generally don’t need attorney involvement.
The more complex, or the more partners or assets that are at stake, the more you may want to get an attorney involved.
Last, laws generally vary by state, so we recommend you check the laws in your state, or seek legal help through non-profit entities to help you along in your journey.
If you have any questions, we are here to help. Just click on the link below, and we will be more than willing to discuss how we can help you effectively manage your asset, and how to form the appropriate structure for your needs.
You can also join our landlord and property investor newsletter below, and stay up to date on the tips and tricks to make you a successful property investor.
The Team at Linchpin Property Management