3.2 LIABILITY
3.201 In General.
A. Limited Liability. When choosing the form of a business entity, the practitioner and the client often find themselves sacrificing entity flexibility in order to protect the entity's owners from personal liability for the obligations and debts of the entity. One of the primary advantages of an LLC formed under the Act is that it offers owners, managers, and agents of the LLC limited liability and pass-through tax treatment without restricting the flexibility of the entity. 2 Section 13.1-1019 of the Act provides: "no member, manager, organizer or other agent of a limited liability company, regardless of whether the limited liability company has a single member or multiple members, shall have any personal obligation for any liabilities of a limited liability company, whether such liabilities arise in contract, tort or otherwise, solely by reason of being a member, manager, organizer or agent."
Similar benefits can be obtained by the use of an S corporation or limited partnership, but there are restrictions, and ongoing corporate formalities must be followed. An S corporation is subject to corporate formalities and restrictions on stock ownership; for example, a nonresident alien may not be a shareholder, and the maximum number of shareholders that an S corporation can have is 100. A "family" is counted as one shareholder. The ability to have limited liability and own and actively participate in management activities is one of the primary distinctions between an LLC and a limited
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partnership. Under the Virginia Revised Uniform Limited Partnership Act, 3 a limited partner who participates in the management and control of the business may become personally liable for partnership obligations 4 unless the limited partnership is a registered limited liability partnership. 5 With an LLC, owners may actively participate in the management and control of the business while enjoying limited liability.
B. Exceptions. Some states have adopted liberal statutes that disclaim any and all liability for the debts of an LLC. 6 As previously mentioned, under the Virginia LLC Act no member, manager, organizer or other agent of the LLC, regardless of whether the LLC has a single member or multiple members, has personal liability for any liabilities of the LLC solely by reason of being a member, manager, organizer or agent of the LLC. 7 It should be noted, however, that the Virginia LLC Act is not an absolute bar to personal liability. For example, under the Virginia LLC Act, a member may waive limited liability if expressly provided in the articles of organization. 8 The articles of organization or operating agreement could also require or provide for capital calls. A practitioner representing a potential member of an LLC should carefully review the LLC organizational documents for these issues.
Additionally, a member may have personal liability arising out of contractual obligations or tort liability. For example, a member has contractual personal liability if he or she personally guarantees a bank debt of the LLC. A member or manager may also be held liable in tort for damages resulting from his or her own negligence or wrongful act, even if the negligence arose in the course of performing his or her duties for the LLC.
Finally, a member may be held personally liable under various statutes or by operation of law in the following instances: (i) for wrongful distributions that the LLC makes to the member; 9 (ii) for any obligations to
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contribute cash or property to the LLC or to perform services; 10 (iii) for breach of an agreement with the LLC; (iv) as a "responsible person" under federal, state, and local tax laws; (v) as an "operator" under the Comprehensive Environmental Response, Compensation and Liability Act 11 or similar environmental laws; and (vi) for certain securities law violations.
C. Malpractice Liability. Under the Virginia Professional Limited Liability Company Act, 12 "innocent members" of an LLC are protected from vicarious malpractice liability of the LLC and managers, employees, agents, and co-members in the absence of an indemnification agreement. 13 This has prompted many professionals to convert or consider converting their organizations to LLCs. While shielded from vicarious malpractice liability, members of a PLC nonetheless remain personally liable for their malpractice or that of someone over whom they have supervision or control 14 if they are negligent in that supervision and control. But one Virginia circuit court has held that "Virginia law fails to recognize a 'duty on the part of a partner of an incorporated law firm to supervise an associate as grounds for civil liability.'" 15
Malpractice liability concerns should not be the sole reason for converting to a PLC. The tax implications of such a change must also be considered. Furthermore, most firms discover that it is contract liability (such as contracts for computer equipment and long-term and expensive office leases) rather than malpractice liability that is the major source of personal liability for members. As with a member of an LLC, a member of a PLC is not liable for contractual obligations of the PLC unless he or she has executed a personal guarantee or similar agreement. 16
D. Obligations to Make Additional Contributions. The general rule of limited liability also governs the relationships among members. Absent a written agreement to the contrary, members have no obligation to make additional contributions to the LLC, and there is no right of contribution
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among members. By contrast, the general partners of a partnership have an obligation to contribute to the partnership and to indemnify other partners for losses and obligations incurred in carrying on the business. An LLC may indemnify a member for obligations incurred by the member in carrying on the business. 17 However, to the extent the LLC does not have sufficient insurance or assets to fully indemnify a member, the member cannot look to the individual assets of other members for contribution. This result can be changed by a binding agreement among the members to indemnify in excess of the entity's assets. Such an indemnification agreement may eliminate all or most of the benefit that a limited liability form of business provides because it subjects personal assets to claims of fellow members.
3.202 LLCs Transacting Business in Other States. When evaluating the potential liability of an LLC member, it is important to consider whether the LLC will be doing business in other states or entering into contracts where the governing law is not Virginia law. While every state has authorized the LLC form of business entity, the statutes are not uniform with respect to liability of members of a foreign LLC doing business in the state. It is unclear whether these types of entities will be recognized for limited liability purposes. Practitioners advising LLCs involved in interstate transactions should refer to the laws of each state to determine if there are adverse provisions or case law regarding member liability.
When faced with this situation, the practitioner can take certain steps to mitigate the possibility of personal liability being imposed on LLC members in other states. It may be possible to register the LLC as a foreign LLC in those jurisdictions in which the business is transacted.
Before a foreign court can impose personal liability on a member of an LLC, that court must have personal jurisdiction over the member. The mere fact that the forum state has jurisdiction over the LLC does not mean that jurisdiction automatically extends to members of the LLC. Jurisdiction does not arise vicariously. 18 Members must take some act by which they purposefully avail themselves of the benefits and laws of the forum state. A mere ownership interest in the LLC is not sufficient to give the forum state jurisdiction over a member. 19
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3.203 Personal Liability of Members of Foreign LLCs That Fail to Register in Virginia. Under the Virginia LLC Act, each member, manager, or employee of a foreign LLC transacting business in Virginia without registration is liable for a penalty of up to $5,000 if he or she knows a certificate of authority is required and one has not been obtained. 20 In addition to the monetary penalty, it is a Class 1 misdemeanor to transact or offer to transact business as an LLC without authorization to transact business in Virginia. 21 Practitioners advising Virginia LLCs involved in multi-state transactions should review similar provisions in other states that may subject members or managers to personal liability. Failure to register in Virginia does not subject the managers or members to personal liability except as provided above.
3.204 Piercing the Entity Veil. The equitable remedy of "piercing the entity veil" may be applied to LLCs to impose personal liability on members. There is no legislative history or statutory authority in Virginia to either support or reject this result. Several states have adopted this approach by statutorily importing corporate case law to determine when to pierce the veil of an LLC. 22 In some states, the courts have been willing to adopt this approach. 23 The failure to impose aspects of the corporate "piercing" doctrine to LLCs would create a liability shield for LLC members that is superior to the shield available to corporate shareholders. Thus, it appears logical that traditional factors used in piercing the corporate veil cases should be applied by Virginia courts to LLCs, and the Supreme Court of Virginia has confirmed
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this standard. 24 Commenters have long suggested the use of the same standard. 25 In VanBuren v. Virginia Highlands Orthopaedic Spine Center, LLC 26 the court echoed the Supreme Court of Virginia's view in Cheatle v. Rudd's Swimming Pool Supply Co. 27 that reaching beyond the corporate veil is an extraordinary exception that is...
