What Happens If Your LLC Gets Sued?

Business lawsuits can prove most stressful for LLC owners. If you run an LLC and it gets involved in a legal dispute, you may lose the advantages offered by the structure. These benefits include limited liability protection that separates you from an LLC’s legal obligations.

Today, we discuss how litigation can affect you and your LLC’s legal protection.

Key Takeaways

• LLCs are often held liable for any debts or legal issues they face during operations. There are exceptions to this rule, though.
• You may face personal liability if you make personal guarantees to a creditor or commit negligence while operating your LLC. Courts can also hold you liable for the LLC’s legal obligations by “piercing the corporate veil.”
• The litigation process for LLCs starts when it receives an initial complaint and summons from a plaintiff. Both parties can negotiate a settlement before going to trial, although their case may enter the discovery phase if negotiations fall through.
• Creditors can seize many types of assets to satisfy a court’s judgment, including business equipment and real estate. Effective strategies can help protect these assets from seizure.
• During the litigation process, make sure to estimate potential legal defense costs and continue operating.

How Does an LLC’s Liability Protection Work?

When a lawsuit is filed against your LLC, it usually targets the business instead of you, the owner. In other words, the LLC is held responsible for its incurred debts and liabilities.

However, this protection has limitations. The following can make you personally liable for your LLC’s legal obligations.

Personal Guarantees or Paying Business Debts

Generally, LLC owners who don’t personally guarantee or promise to pay their venture’s debts won’t be held liable for business debts. This means creditors can seize your LLC’s property but not your personal property.

Nevertheless, most creditors want to avoid taking responsibility for an LLC’s operational issues. Hence, they can ask you for a personal guarantee for business loans, credit cards, or other extensions of credit to your LLC. You can be held liable for the business’s debts if you grant this demand.

The Owner’s Actions

In all states, personal liability applies to LLC owners who showed wrongful conduct while conducting business. This can extend to their ventures, meaning that creditors can seize business and personal assets as ordered by the court.

Piercing the Corporate Veil

When courts “pierce the corporate veil,” LLC owners can be held liable for their business’s obligations. Many courts conduct a two-part test that determines:

• Whether the LLC is truly separate from its owner(s)
• If the business owner(s) or decision maker(s) committed fraud or wrongdoing

Furthermore, several factors help courts decide whether to pierce an LLC’s corporate veil. They include the company’s size, potential commingling of personal and business funds, and inadequate capitalization of the LLC.

What to Expect from Litigation

The litigation process against an LLC starts with the service of process. Your LLC must have a registered agent to receive legal documents, and this agent will typically be served with the initial complaint and summons. Once your LLC receives both, it must respond to the plaintiff immediately.

Your Initial Response & Legal Assistance

Current state and federal court guidelines determine how long it takes for LLCs to respond to legal action against them. On one hand, state courts will let your business answer a complaint in around 30 days. There’s also a “Notice to Defend” that tells you to respond within 20 days.

For complaints filed in federal court, your LLC must answer them within 21 days. It can also “waive service,” so the initial complaint and summons will be served in 60 days.

Upon receiving a complaint, contact your business attorney or legal counsel. Never attempt to handle small business legal issues of this magnitude without professional guidance. Your attorney will examine the claims, assess the strength of your potential defense, and discuss how to best handle the lawsuit.

Usually, the defendants in a lawsuit file their response, with affirmative defenses or counterclaims included, in state or federal court. This document influences how the entire litigation process works and protects your rights during this time.

Settlements Between Involved Parties

Most business lawsuits go through settlements before an actual trial can be conducted. Throughout this process, your legal counsel must evaluate the strengths and weaknesses of your LLC’s case. This determines whether the business and the complainant can reach a settlement or not.

The Discovery & Investigation Phase

If your LLC goes to trial, its case enters the discovery phase. Both parties present important information, documents, and testimony here. The discovery phase can be time-consuming, as your business and the plaintiff can counter each other’s claims.

During this phase of the litigation process, expect to provide evidence related to your case and potentially sit for depositions. The plaintiff gathers evidence supporting their claims while you work to build your defense.

What Assets Can Be Seized In Lawsuits?

Many types of assets can be seized in lawsuits. Here are some of the most common ones pursued by creditors:

• The money deposited into bank accounts
• Wages or investment accounts under your name or LLC
• Retirement or state and federal benefits
• Business equipment
• Real estate, including your personal home

How to Protect Assets from Litigation

Legal issues can increase the risk of your business and personal assets being seized. Here’s how to protect both from litigation and its potential consequences.

Get Business Liability Insurance

Business liability insurance offers asset protection and coverage for your LLC’s legal liabilities. Additionally, it pays for the venture’s legal defense, final settlements, or awards to pay to a plaintiff (such as compensatory damages, an injured individual’s non-monetary losses, and punitive damages).

If you decide to get this type of insurance, consider policies with limits that can protect your LLC’s assets well. Adequate coverage costs less than your venture’s exposure to uninsured claims.

Draft & Update Your Operating Agreement

Your LLC’s operating agreement plays a crucial role in preventing lawsuits (and responding to them). At most, it clearly defines who owns the business, what members are entitled to, and what they do for the LLC.

Some operating agreements can also include provisions that make your LLC less attractive to potential investors. In that case, consider including clauses about charging order protection, transfer restriction, and dispute resolution in your operating agreement. These provisions can limit creditor remedies and add protection to your LLC’s operations.

Set Up an Asset Protection Trust

An asset protection trust is an irrevocable trust that can help you protect assets from creditors. It can be a domestic (held in the U.S.) or an offshore (outside the U.S.) trust. However, take note that you’re only allowed to set up a domestic trust in certain states. You may want to research where to do so.

Setting up an asset protection trust works best if you have a high net worth or a job that’s most likely to face a lawsuit.

To get other effective asset protection strategies, watch the Ask NCH video below.

Can Forming a Nevada LLC Help With Asset Protection?

Forming a Nevada LLC can help you protect your assets, as it reduces your liability for the company’s legal obligations. And if an LLC member incurs debts, Nevada courts can grant the person’s creditor a charging order to pursue their ownership interest in the business. The creditor can request the LLC to pay them any distributions given to the indebted member.

Start Forming a Nevada LLC Today

How to Manage Litigation Costs & Business Operations

Lawsuits can cost a lot and disrupt your business operations. Consider taking the following steps to ensure your business survives the litigation process regardless of the outcome.

Determine Potential Legal Expenses

Your LLC’s litigation expenses can increase rapidly. To reduce these costs, choose a lawyer who offers their expertise at a fee that suits your budget. Also, check whether your business liability insurance policy (if you already have one) covers legal defense costs.

Maintain Business Continuity

Most importantly, try to stay business as usual throughout litigation. Since your customers, vendors, and employees may raise doubts about your LLC’s stability, make clear communication and consistent performance your top priorities.

Furthermore, consider litigation’s effect on your business relationships. Ideally, you should inform your business partners, clients, and employees about potential legal action taken against your LLC. Proactive disclosure is more effective than keeping legal matters secret.

Frequently Asked Questions

Can I be held personally liable if my LLC gets sued?

No, you can’t be held personally liable if your LLC gets sued. That’s because the business separates you from its liabilities. But if you make a personal guarantee, commit negligence, or commingled personal and business funds, the courts may hold you responsible for the LLC’s obligations.

What assets can be seized if my LLC loses a lawsuit?

The assets that can be seized if your LLC loses a lawsuit include:

• Cash in business bank accounts
• Company equipment
• Real estate owned by you and your LLC

Personal assets can’t be seized unless courts pierce the corporate veil after finding that you’ve commingled funds or undercapitalized your business.

Can my personal assets be seized if my LLC gets sued?

Because your LLC protects you from its legal obligations, your personal assets won’t necessarily be seized. However, creditors may take your personal assets if personal guarantees or negligent or wrongful behavior makes you liable for your LLC’s obligations.

What happens to my LLC’s bank accounts during a lawsuit?

Your LLC’s bank accounts can be frozen or seized during a lawsuit. This depends on what a state or federal court’s judgment would be.

For instance, courts may order your venture to stop using your business bank account during litigation. As a result, business operations may be disrupted.

What should I do if my LLC gets sued?

If your LLC gets sued, contact a business attorney immediately. Make sure to respond to the initial complaint within the specified time limit, but let your legal counsel review it first. They should advise you on your next steps and gather the evidence to support your case.

Also, be careful not to move or hide assets after being served. This can affect your case.

How much does it cost to defend an LLC lawsuit?

The cost of defending an LLC lawsuit varies widely.

Litigation costs for minor commercial disputes can reach thousands of dollars, while those for major lawsuits can reach over $1 million. However, these numbers vary depending on several factors, including how complex the lawsuit is.

Should I get business liability insurance to cover litigation costs?

Yes, you should get business liability insurance to cover litigation costs. Just make sure to choose a policy with adequate coverage.

Additionally, you can have professional liability insurance or industry-specific ones. Consider your LLC’s specific activities before getting these types of insurance.

How long do LLC lawsuits take to resolve?

LLC lawsuits can take months or even years to resolve. Many cases are settled out of court first, meaning your LLC’s lawsuit can end without going to trial. Otherwise, the litigation process will take longer than expected.

Should I consider settling quickly to avoid legal costs?

You should consider settling quickly to avoid legal costs. However, your case must convince the plaintiff to reach a settlement with your business.

It’s worth noting that most complainants will demand high settlement amounts, so you may need to evaluate their offer. Your legal counsel should guide you through this process.

Can I transfer LLC assets after being served with a lawsuit?

As we’ve mentioned, transferring LLC assets after being served with a lawsuit isn’t recommended. Courts may consider it a fraudulent act, and you may get additional penalties for it. LLC asset protection strategies should be used before your business faces potential litigation.

Expert Tips From NCH

1. Continue to follow corporate formalities during the litigation process. Courts will look at your LLC’s operations more carefully while it stands trial.
2. Keep business and personal finances separate. Your venture’s corporate veil can be pierced if courts prove that you’ve commingled funds while doing business.
3. Consider forming a Nevada LLC for asset protection. The state’s charging order protection can keep creditors from pursuing your personal assets.

Protect Your Business Through Legal Challenges

When your LLC faces a lawsuit, you won’t be held liability for its legal obligations. However, the business may lose this protection if you’ve taken certain actions that make personal liability applicable to you. Preparation, legal guidance, and compliance with corporate formalities are your keys to protecting your LLC before and during litigation.

NCH’s legal experts can help your LLC stay compliant and avoid lawsuits.

Contact Us For Professional Assistance Today

DISCLAIMER: The above material has been prepared for informational purposes only, containing opinions of the provider and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. Please consider consulting tax, legal, and accounting advisors before engaging in any transaction.