Assessing Personal Liability – Read Formation Documents Carefully!

A client, majority shareholder in a California corporation, asked whether there was any way to make a minority shareholder pay part of the corporation’s losses to date. In this particular case, the answer was “no” – but the question got me thinking about when a corporate shareholder or LLC member might be have personal liability beyond the amount payable for the ownership interest.

The LLC section reference and content below have been updated to reflect California?s new LLC law that took effect on January 1, 2014 (see RULLCA Brings New LLC Laws to California in 2014).

A century ago, corporations routinely issued assessable shares, i.e., shares that carried an obligation for the shareholder to pay additional amounts to the corporation under certain circumstances, such as to cover losses or to buy property. Today, however, almost all shares are non-assessable.

In California, shares are assessable only if the articles of incorporation so state (Corporations Code Section 204(a)(1)). Corporations Code Section 423 provides detailed procedures by which the board of directors may levy and collect assessments.

With respect to limited liability companies (LLCs), obligations to make contributions are set forth in the operating agreement. In addition,? Corporations Code Section 17703.04(c) states that members may be liable to third parties as a result of participating in tortious conduct or pursuant to an agreement other than an operating agreement.

Please note that the foregoing are separate from and in addition to personal guarantees that landlords or lenders may require from the founders of startup companies.

In summary, while assessments are rare, if you are going to invest in a corporation or an LLC, it would not hurt to look at the articles of incorporation or, as applicable, the articles of organization and the operating agreement, to ensure that there are no assessment obligations. Besides, if you look at the formation documents closely, there is no telling what other interesting information you might find!

Photo credit: Dani Simmonds via stock.xchng

This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact a lawyer directly.