Under California law, the members (owners) of an LLC are only liable for the amount of capital that they have put into the LLC. However, under certain circumstances, a creditor to the LLC can “pierce the corporate veil,” and the member(s) will be held personally liable for the debts and obligations of the company. Piercing the corporate veil is a rare occurrence, but the following is a list of important points that the members should keep in mind as they operate the company so they can avoid personal liability. These points support one important concept: the members should treat the company as an entity of its own, separate and apart from the personal affairs of the members.
1. All company assets should be titled in the name of the company. This includes having a separate bank account for the company and using the company’s name as the owner for any assets it purchases (i.e. cars, real estate, etc.).
2. All company contracts should be in the name of the company. The company itself is party to its contracts, and the contract should be signed by an authorized individual at the company. The individual always signs with his/her title at the company.
3. The company should keep enough money in its bank account to pay for upcoming obligations. Again, the members should treat the company like an entity of its own. If the members are consistently taking all of the money out of the LLC’s account by making distributions to themselves, this gives the appearance that the LLC bank account is really being used as the members’ personal account. Of course, members can take distributions. But they should always keep the LLC properly funded. California law states that an LLC may not make a distribution to its members if the LLC would not be able to pay its debts as they become due in the usual course of business, or if total assets would be less than the sum of the total liabilities.
4. When the company takes major action, the members should document the action that was taken and keep this with the corporate records. For example, if the company enters into a lease, the members should make a note that the company approved the terms of the Lease as of the specific date as being in the best interests of the company. Each of the members or the manager should sign this document. This is not required by California law, but it is a “best practice” that is useful in protecting against alter ego liability (i.e. piercing the corporate veil) and in protecting the members in the case of an IRS challenge.
5. The members or manager must maintain proper records. Under California law, an LLC must have an office in California where it maintains the following records: (a) a list of all members including their names, addresses and capital contribution; (b) if the LLC is manager-managed, a list of the name and address of the manager(s); (c) a copy of the articles of organization and all amendments; (d) copies of federal, state and local income tax returns for the last six years; (e) a copy of the operating agreement; (f) copies of financial statements for the last six years; (g) the books and records of the internal affairs of the LLC for the past four years and the current year (this would be actions taken under #4 above) and (h) if the LLC owns real property, copies of records of the amount, cost and value of all of the real property. I recommend that these documents be kept in the corporate book or an easily accessible computer file (with printer access). Each member and manager has a right to inspect and copy these records.