Exceptions to Full-Shield Limited Liability

April 13, 2006

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Some organizational forms offer owners better limited liability protections than others. For example, many states grant the owners of an limited liability partnership (LLP) less liability protection than the owners of an limited liability company (LLC).

Specifically, many states only offer what is termed a "limited shield" of liability. This means that limited liability is reduced. In particular, a limited shield means that the owners the LLP will have limited liability only with respect to actions of their co-owners; owners will still have unlimited, personal liability in all other cases, meaning all of their personal assets outside the business will be exposed to liability.

For example, if the business sold a defective product that injured a customer, the owners could be sued personally. Similarly, if an employee of the LLP injured someone while carrying out the LLP's business, all of the owners of the LLP would have unlimited, personal liability.

The reluctance by many states to grant the owners of an LLP a "full shield" is probably due to the fact that nearly all LLPs were general partnerships that have been converted to the LLP form. It was probably too radical of an idea for legislators in many states to go from unlimited, personal liability for all the owners of the business (i.e., general partnership) to full limited liability.

Further, even when a "full shield" is offered, the business interests of the owners of an LLP are still not offered the same protection from the claims of their personal creditors that the owners achieve in the LLC. For this reason, the LLP is usually not a good choice for the small business owner.

Warning

Unknown to many small business owners, there are, in fact, major exceptions to limited liability, often in the form of liability for contracts and torts, as well as from improper business practices that result in a court piercing the veil of limited liability. When an exception applies, the owners of the business have unlimited, personal liability for all of the business's debts.

With planning, the potential damage caused by these exceptions can be reduced or eliminated (identifying your vulnerabilities is the focus of asset exemption planning).