Operating LLCs

Improperly Worded Company Contracts can Cause Signer to be Liable

One of the primary reasons people form limited liability companies and corporations is to protect the owners from the debts and liabilities of the company.  The general rule of Arizona law is that the members of an Arizona LLC and the shareholders of an Arizona corporation are not liable for the company’s debts.  One of the biggest exceptions to this rule arises when an owner signs a contract and becomes personally obligated to pay the company’s debt.

The Personal Guaranty

The most common type of contract that obligates an owner of a company to pay the company’s debts is called a “guaranty” or “personal guaranty.”  A guaranty is a contract by which the signer/guarantor promises to pay or satisfy the debt of another person (the company).  Guaranties are frequently required by landlords and lenders who know that if the company doesn’t pay, the debt will never be paid.  Arizona law provides that if only one spouse signs a guaranty, then the debt cannot be collected from the community property of the guarantor and his or her spouse.

Contracts that Create Personal Liability

Owners and employees of a company can create contractual personal liability for themselves if they sign a contract on behalf of the company, but the wording of the contract does not make it clear that the signer is signing on behalf of a company.  The Arizona LLC Quick Start Guide that I give every LLC that I form contains actual examples of the exact language that should be used in contracts to prevent the signer from inadvertently becoming personally liable to pay the company’s debt created under the contract.

If the signer of an LLC or corporate contract wants to avoid becoming personally liable for the debts of the company created in the contract, the language in the contract must clearly state that the party is the LLC or corporation and indicate the capacity of the signer.

Iowa limited liability company and corporate attorney Marc Ward reports on a recent Iowa case that where the court found that the person who signed a two page contract on behalf of a corporation was personally liable to pay the corporation’s debt under the contract.

The Iowa Court of Appeals opinion in Builders Kitchen and Supply Co. v. Moyer, N0. 0-655/09-0194 (September 2, 2009) is a deceptively simple case. On the one hand it represents the folly of not having even run of the mill contracts reviewed by lawyers before they are signed. And on the other hand, it is a warning to lawyers that things aren’t as simple as they appear.

Unfortunately for Moyer the contract contained a clause that said “I hereby personally guarantee to pay on demand any and all sums due that my/our company shall fail to pay.”

Mr. Moyer did not sign the signature block for the personal guaranty, but the court found he was liable anyway.

Proper Way to Sign Contracts

Right Way to Designate the Company in a Contract:  World Wide Widgets, LLC, an Arizona limited liability company.  Note the LLC after the name and the written out “limited liability company.”   Make sure both the abbreviation and the full designation are used.  Typically the proper designation of the company should be in the first paragraph and in the actual signature block where the signer signs.  If it is not, the signer should hand write the missing information above where he or she signs and/or on the first paragraph where the company is named.

Right Way to Designate the Capacity of a Signer in a Contract:  Homer Simpson, President (for an Arizona corporation), or Homer Simpson, Manager (for a manager-managed Arizona LLC), or Homer Simpson, member (for a member-managed Arizona LLC).

Wrong Way to Designate the Company in a Contract:  World Wide Widgets

Wrong Way to Designate the Capacity of a Signer in a Contract:  Homer Simpson.

Beware of Personal Guaranty Language in the Contract

If a contract contains any language that would cause the signer to be a guarantor and impose personal liability on the signer, the signer who wants to avoid personal liability must take a pen and cross-out or strike-out all of the guaranty language.  If you are signing a contract, you must read it and strike-out any language you don’t want and write on the document any additional language you want.  You can modify with hand-written changes all pre-printed contracts before signing.