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Under some circumstances, Individual members of LLC's or shareholders of corporations can shield themselves from personal liability to third parties and limit it to their membership or shareholder investment. There are limits to effectiveness of this shielding, and yet it may be more effective than simply being a sole proprietorship. The protection of a corporation can be affected by lawsuits attempting to "pierce the corporate veil" and similar attacks can be made on LLC's. Imagine the owner of grooming business who knowingly abused a pet that died (uncommon, but it does happen). Under these extreme circumstances the law may uphold making the members or shareholders personally liable for what might otherwise be debts and obligations of the LLC or corporation. Certainly the sole proprietor involved in such a situation would unquestionably have no protection at all in such a lawsuit.

The basis of allegations involved in such lawsuit to pierce liability protection is "alter ego." California Corporations Code, section 17101 provides in part:

(a) 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...

(b) A member of a limited liability company shall be subject to liability under the common law governing alter ego liability, and shall also be personally liable under a judgment of a court or for any debt, obligation, or liability of the limited liability company, whether that liability or obligation arises in contract, tort, or otherwise, under the same or similar circumstances and to the same extent as a shareholder of a corporation may be personally liable...except that the failure to hold meetings of members or managers or the failure to observe formalities pertaining to the calling or conduct of meetings shall not be considered a factor tending to establish that a member or the members have alter ego or personal liability for any debt, obligation, or liability of the limited liability company where the articles of organization or operating agreement do not expressly require the holding of meetings of members or managers.

On the surface, these two cites seem in opposition. However, they are not. Section (a) provides a shield against the mere allegation or proof that a person was a member and nothing more. The same would be true of a shareholder in a corporation. The missing link to understanding the depletion of the "shielding" is Section (b). It clearly states that a member of a LLC can be liable to the same extent as a shareholder of a corporation under the law of "alter ego."

To avoid this, the LLC or corporation must be treated as a completely separate entity from its members or shareholders. It cannot be treated as merely an extension of the member or shareholder. This means that he member or shareholder cannot withdraw monies from the LLC or corporation at will. Bank accounts must set up in proper order too making clear the separation, very clear.

There are more cracks which creditor lawsuits will attempt to find and use to pierce the veil. There are formalities that must be followed whether an entity is a corporation or LLC. In the corporate world, regular and annual meetings are expected, and notices of such meetings must be properly distributed, signed and filed, or waiver notices of these meetings properly handled. When they are not, the corporation has a crack that may be attacked. As noted in section (b) above, one of the exceptions to the liability issue in LLC's is that the failure to observe formalities cannot be used by such creditors as proof of the alter ego liability provided that the articles of organization or the operating agreement do not expressly require the holding of such meetings. Thus, when your form your entity and prepare these documents, you must be absolutely certain that the "forms" you are using do not state that such meetings are required. Ask your counsel about this requirement in documents they prepare when assisting you to form your entity.

In California, a member of a LLC can also be liable if the member has expressly agreed to be liable under a written guarantee. Behavior of a member or shareholder can be classified as "tortious conduct" and again open the path to liability. Again, severe mishandling of pets where neglect, harm or malicious handling is involved is certainly open to rulings of "tortious conduct."

Here we have looked at the most common misunderstandings, especially that just having a LLC or corporation is perfect protection. You need legal and financial guidance when forming a LLC or corporation, and don't treat it just as a set of papers you sign. Not all organization papers are the same. Read all documents, and ask questions. It is the liability of the professional taking money to provide you with services to answer your questions, so do so. Be warned that we never suggest using do-it-yourself organization kits and software for matters of company formation.

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