Small Business

Who Pays a Failed LLC's Debts?


In theory, if a limited-liability company cannot pay up, then landlords and other creditors cannot come after the owners' personal assets

My spouse and I owned an LLC that closed last October. We filed dissolution with the state. We had a five-year lease agreement that has two years left on it. Although the business is now closed, the landlord has sent us collections notices for partial payments through October '08 as well as the lease payment and utility bills for 2009. We can't pay, and now he's trying to garnish our wages. Are we personally liable for these debts although our business is dissolved? We cannot afford a lawyer. —L.P.N., Green Bay, Wis.

Generally speaking, if your limited-liability company (LLC) was properly formed and operated, you should be protected from personal liability for its debts. "That means that if the LLC cannot pay its creditors, including landlords, then those creditors cannot come after the personal possessions of the LLC owners," says Stephanie Rahlfs, an attorney and editor at legal site FindLaw.

Creditors of a valid LLC can collect only from the assets of the company, not personal assets or wages, and garnishments cannot be used against wages unless a money judgment has been awarded in court.

Personal Guarantees?

"It is possible that your prior landlord is incorrectly pursuing you and your spouse instead of the LLC. You need to carefully review the lease agreement to determine whether the now closed LLC is liable for the unpaid rent or whether you are personally liable," says Russell Morse, a real estate lawyer at Los Angeles' Truman & Elliott.

Unfortunately, it's also possible that you took some action while your company was in business that removed the protection of your LLC, such as signing a personal guarantee with the landlord or mingling personal and company funds.

"The LLC's activities, and especially its finances, must be operated completely separate from those of the members of the LLC," Morse says. Liability protection also would not be available to you if you had intentionally committed fraud or failed to deposit taxes withheld from employee wages.

Sit down and look over your LLC operating agreement, which is the organizational document for your former company, and make sure you have followed proper procedures for forming, operating, and dissolving the company. If you have, that will help make your case that you should not be personally liable for the debts of your former company.

Entirely Separate

"The most important factor in ensuring liability protection is to treat the LLC as a separate entity. If a court feels that the owners have been treating the LLC as an extension of their personal affairs, then the court will often find that the LLC never really existed and that the owners were doing business as individuals. In that case, the court may find that, despite the fact that an LLC was in place, the individual owners are personally liable for the LLC's debts," Rahlfs says.

Try contacting the state bar in Wisconsin, which provides pro bono legal aid for indigent state residents and sponsors a referral program, through which you may be able to get low-cost or free legal help to review your documents and determine your liabilities

The bad news is that if you signed a personal guarantee, you may have little legal recourse. A personal guarantee means that you are individually on the hook for your company's debt, says John A. Logan, a real estate law specialist at Laff Campbell Tucker & Gordon in Greenwood Village, Colo.

Business owners who are asked to sign personal guarantees for leases can limit their exposure by offering their landlords larger security deposits or letters of credit in lieu of a personal guaranty. "Other landlords will allow you to cap a guaranty at a certain amount, say six months of rent. Still others will allow the guaranty to expire if there has not been any default after a year or so," Logan says.

In general, having an LLC operating agreement, maintaining a separate business bank accounts, obtaining a federal employer identification number, and properly funding the LLC can all help to protect individual owners from liability. It is also always smart to have business insurance in place to protect business owners in cases like yours.

Karen E. Klein is a Los Angeles-based writer who covers entrepreneurship and small-business issues.

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