Like a corporation, a limited liability company (LLC) is liable for its obligations to others. No other person, as owner or agent, is vicariously liable for those same obligations. An LLC, like any entity, must act through people or other legal entities with the authority to act for the LLC. The person or legal entity with this authority may be called different things: manager, managing member, authorized person, officer, employee, or just agent (“Actors”). Under all LLC statutes, the general rule is that LLC members are not personally liable for obligations of the LLC, subject to exceptions like personal guarantees or piercing of the LLC’s veil.
This memo discusses a different aspect of indirect liability: when an Actor will be liable to a third party for actions taken on the LLC’s behalf. It does not address the liability of the LLC (or its owners) to the third party or the relationship between the LLC and its Actors.
Whether an Actor is personally liable to a third party for an obligation incurred by the Actor while acting for the LLC turns on: (1) whether the obligation is based on a contract or a breach of duty; (2) whether the duty breached by the Actor is a duty to the LLC or the third party; and (3) if the obligation is a liability for damages, whether the damages are physical harm to the third party’s person or property or for economic loss suffered by the third party.
CONTRACT
Actors are generally subject to the same rules as other agents. The general rule is that an Actor is not a party to – and not liable to – a third party on a contract between a fully-disclosed principal (the LLC) and a third party, even if the Actor, as Actor, negotiates and performs the contract. This is based on the concept that the Actor is creating a contract binding on its principal and the third party is relying on the principal for performance. Other than the Actor’s duty to the principal and his pledge of authority to the third party insuring the Actor has the legal power to bind the LLC, the Actor does not have an individual role in the contract.
The Actor can change this by agreement. The Actor’s guaranty of the contract is one way. Otherwise, when an Actor enters into a contract with a third party, the third party’s relief under the contract is limited to the LLC. The Actor’s conduct in entering into or performing the contract is immaterial to the liability for breach. If the Actor is performing the contract for the LLC, the only person to whom the Actor answers is the LLC.
TORT
The rule is different when an Actor commits a tort (a non-contract-based duty to a third party) that results in damage to a third party. An Actor is liable to a third party harmed by the Actor’s conduct, regardless whether the Actor is acting in a representative capacity or whether the LLC is also liable to the third party. An example is an Actor who negligently causes an automobile accident while driving in the course of her duties as Actor for an LLC. The Actor is personally liable to the third party injured in the accident. This is true regardless whether the LLC is also liable to the injured third party. Many LLC laws recognize this rule, although they say it in different ways.
Not all conduct of an Actor that creates liability to a third party will make the Actor liable to the third party. The action must violate a duty owed directly by the Actor to the third party. Anyone, including an Actor, who drives a car on a public road owes a duty to others on the road not to cause damage to them through negligence. An Actor’s breach of a duty owed to the LLC is not an independent basis for her liability to a third party. For example, when a player’s agent negotiates a contract with a third party for the player’s services and then does not tell the player about the contract or the player says he cannot perform, but the agent does not tell the third party, the third party may not recover damages for agent’s negligence because the agent owes a duty to the player; not the third party.
PHYSICAL HARM VS. ECONOMIC LOSS
Even if the third party has a claim for negligence, the liability of each of the Actor and the LLC may be limited by the economic loss rule. This rule says there is no liability in negligence for causing pure economic loss. Economic loss for this rule means a loss or damage other than from personal injury or physical damage to property. It generally prohibits recovery of lost profits, loss of value, lost opportunity and other financial losses.
The economic loss rule is not universal. Some states use a more limited rule. The more limited view is that an Actor has no general duty to avoid the accidental infliction of economic loss on another or that there is no liability for economic loss caused by negligence in performing or negotiating a contract.
While the basic rules on economic loss are not simple, they are an important limit on liability. The basis for economic loss rules is that, in matters involving economic loss, the contract - if there is one - should govern, even where the damage comes from the negligence of one of the parties. The argument is that the parties can establish the standards of conduct between them and protect themselves from a failure to meet them.
There are important exceptions to this protection. The protection does not apply to professional services or fraud. Fraudulent or negligent misrepresentations by an Actor will subject the Actor to liability even if it happened in negotiating or performing a contract.
APPLICATION OF LLC STATUTES
All of the concepts will be generally applicable to persons acting on behalf of limited liability partnerships and corporations, and, with respect to all persons other than general partners, limited and general partnerships. Those rules that are based on agency principles will apply to all agents.
There are some rules that may have unique application to LLCs due to state LLC legislation. Many of the LLC laws have an expressly say that Actors (sometimes limited to statutorily-defined managers, sometimes including employees and other agents) are not liable solely by reason of being or acting as an Actor.
The laws divide into three general categories: (1) silence on the liability of Actors, (2) a general statement that managers are not liable for the obligations of the LLC, or (3) a statement that managers (or, in some cases, all Actors) are not liable for the obligations of the LLC solely by reason of (being or acting as) a manager (or other Actor).
In addition, some of the laws providing for non-liability of managers or other Actors include an express exception for Actors who are professionals.
A few cases have considered the liability of managers or managing members under laws that say a member or manager is not liable for a debt or obligation solely by reason of being or acting as a member or manager. Illinois held that the manager of an LLC was not personally liable in connection with a warranty of condition of certain sewer lines and promise to conduct further testing of those lines made by an LLC. Similarly, South Carolina concluded that a member of the LLC that acted as contractor on a construction project owed no duty to the property owner for construction defects.
Both of these cases looked at legislative history which says that a member or manager, as an agent of the company, is not liable for the debts, obligations, and liabilities of the company simply because of the agency. A member or manager is responsible for acts or omissions to the extent those acts or omissions would be actionable in contract or tort against the member or manager if that person were acting in an individual capacity.
CONCLUSION
Much attention has been given to the liability of members as owners of an LLC because members are not vicariously liable for the obligations of the LLC solely by reason of their status as owners. This distinguishes them from general partners in general and limited partnerships. Only recently has the liability of Actors in LLCs and other organizations for actions taken on in their capacity as agents of the organization become the subject of extensive legal analysis. Recent case law, and statutory provisions have focused greater attention on this issue and provide some guideposts that may help in developing a clear set of principles. As a general matter, the following rules should apply:
To the extent that an LLC’s obligation to third party liability arises under a contract between the LLC and the third party, the Actor will not be liable even if the Actor is instrumental in entering into or performing the contract for the third party
To the extent that an Actor is negligent in performing his or her duties for the LLC, the Actor will not be liable to a third party for any damage incurred by the third party unless the Actor owed an independent duty to the third party.
To the extent a third party sustains economic harm (harm other than personal injury or injury to the third party’s property) as a result of the negligence or other tort committed by an Actor in the course of negotiating or performing a contract between the LLC and third party, the Actor will not be liable to the third party under the economic loss rule.
An Actor will be liable to a third party for damages resulting from the Actor’s actions if: (1) the Actor is a professional in the context of the LLC’s rendition of professional services to the third party or (2) the Actor has made fraudulent misrepresentations.
Each of these rules are subject to exceptions, qualifications, and nuances. They do not deal with the liability of the Actor to the LLC or the liability of the LLC to the third party.
There are many other factors that may impact the liability of an Actor to a third party. For example, the agent may agree to become a party to a contract or may be subject to liability under other state statutory or common law.
The important lesson is that the liability of a manager or other Actor for actions taken on behalf of an LLC of which she acts is neither automatic nor totally precluded. In determining that liability, a court will analyze the nature of action, duties owed by the Actor and to whom the duties are owed, the nature of the damages, and the language and intent of the state LLC statute. The cost and uncertainty of this analysis strongly argues for contract language that is clear the beginning of the transaction.