5 Ways Your LLC Will Fail When You Need It Most
Meta Description: Discover the 5 most common reasons LLCs provide zero protection in court. Learn what destroys asset protection and how to avoid these fatal mistakes.
The LLC That Looked Perfect on Paper
An investor spent $1,200 with an online service to form his LLC. He received: - Certificate of Formation - EIN from the IRS - Operating agreement template - Registered agent service
He put his 3 rental properties "in the LLC" (or so he thought).
Three years later, a tenant sued him for $300,000. The investor felt confident—he had an LLC. His assets were protected.
Then the plaintiff's attorney filed a motion to pierce the corporate veil. The motion listed 7 reasons why the LLC should be disregarded as a sham entity.
The investor couldn't refute any of them.
The judge's ruling: "This LLC exists only on paper and provides no legitimate business purpose beyond asset protection. The corporate veil is pierced. Plaintiff may proceed against defendant's personal assets."
The LLC failed. Not because the investor did anything intentionally wrong. But because he didn't know what he didn't know.
When Courts Disregard Your LLC
Here's what investors need to understand:
Forming an LLC is easy. Making it work is hard.
Courts don't automatically respect your LLC. They test it. And if your LLC fails the test, they pierce the corporate veil and allow creditors to reach your personal assets.
The legal standard: Did you treat the LLC as a real, separate business entity? Or did you treat it as your personal asset with a thin corporate shell?
If the latter, the LLC provides zero protection.
The 5 Most Common LLC Failures
There are many ways LLCs can fail. These are the five I see most often—and the five that most commonly destroy protection when you're sued:
Failure #1: No Operating Agreement (or Unsigned Operating Agreement)
The mistake: - LLC formed with the state, but no operating agreement created - Or operating agreement downloaded/drafted but never actually signed
Why it's fatal:
An operating agreement is the internal document that governs how your LLC operates. It establishes: - Member rights and obligations - How the LLC is managed - How profits and losses are allocated - What happens when members die or want to exit - Capital contribution requirements - Distribution rules
Without an operating agreement: - You're relying on state default rules (which provide minimal protection) - Courts view the LLC as an afterthought, not a real business - In lawsuits, you can't prove the LLC was operated as a legitimate entity - It's evidence of a "sham" created solely for asset protection
The test: In a lawsuit, the plaintiff's attorney will request your operating agreement in discovery.
If you can't produce a signed operating agreement, you've essentially admitted the LLC wasn't treated as a real business entity.
Even worse: Having an operating agreement that was never signed. This shows you knew you needed one but couldn't be bothered to finalize it. Courts view this as even weaker than having no agreement at all.
What judges think: "If you didn't take this seriously enough to sign the foundational document, why should I respect this entity?"
The fix: Create a comprehensive operating agreement and actually sign it. All members must sign. Keep the executed original in a safe place.
For partnerships: This is even more critical. Without a written partnership agreement, disputes lead to expensive litigation and often business dissolution.
Failure #2: Failure to File Annual Reports
The mistake: Not filing required annual reports or franchise tax returns (in states that require them)
State-specific requirements:
Texas: No annual report required. No annual franchise tax for most small LLCs (under revenue threshold). This is one advantage of Texas LLCs.
Many other states: Annual reports and fees ARE required: - California: Annual $800 franchise tax - New York: Biennial statement required - Delaware: Annual franchise tax and report - Illinois: Annual report required - [Most states have some annual requirement]
Why it's fatal:
If you miss annual reports/fees, the state administratively dissolves your LLC.
Administratively dissolved = the LLC no longer legally exists.
You might not even know it happened. No one calls you. You just get a notice in the mail (which you might miss).
Then you get sued.
Plaintiff's attorney: "Your Honor, the defendant's LLC was administratively dissolved in 2022 for failure to file required reports. The LLC doesn't exist."
Judge: "Motion to pierce granted. The LLC is disregarded."
Your response: "But I didn't know! I thought I was protected!"
Too late.
The doubt this raises:
Even in Texas where we don't have annual reports, most investors don't know whether their state requires them. And if you formed an LLC in another state (maybe you own property there, or a friend recommended "Delaware LLCs"), you may have annual requirements you're unaware of.
The fix: - Know your state's requirements - Calendar annual deadlines - File on time every year - Consider registered agent services that track and remind you
Failure #3: Properties Never Deeded to the LLC
The mistake: Forming an LLC but never actually transferring property deeds to the LLC
How this happens:
Investor forms LLC and thinks: "My properties are now protected by the LLC."
But legally, properties are still titled in their personal name. The LLC doesn't own them.
Why investors skip this step: - Don't know deeds need to be transferred - Think forming the LLC is enough - Worried about mortgage due-on-sale clause - Don't want to pay attorney to prepare deeds - "I'll do it later" (and never do)
Why it's fatal:
The LLC can only protect assets it actually owns.
If property is still deeded in your personal name, the LLC provides zero protection for that property.
In a lawsuit:
Plaintiff's attorney: "Please provide proof that the property at 123 Main Street is owned by the LLC."
You produce: Deed showing property is titled in your personal name
Plaintiff: "Your Honor, the property isn't owned by the LLC. The LLC is irrelevant to this case."
Judge: "Agreed. Plaintiff may proceed against the property and defendant's personal assets."
Your LLC exists. Your LLC is properly formed. But the LLC doesn't own the property, so it provides no protection.
The process to fix: 1. Prepare new deed transferring property from you to your LLC 2. Sign and notarize the deed 3. Record with county clerk 4. Notify mortgage lender (most allow transfers to your own LLC) 5. Update title insurance 6. Update property insurance to show LLC as owner
This isn't optional. This is essential.
Cost: $200-500 per property for attorney to prepare and record deeds
Alternative cost: Losing the property in a lawsuit because the LLC didn't own it
Failure #4: Poor or No Record Keeping
The mistake: Not maintaining separate records, accounts, and documentation for the LLC
What "poor record keeping" looks like: - No annual financial statements for the LLC - No documentation of major decisions - No meeting minutes (even informal) - All receipts thrown in a box, sorted once a year for taxes - No clear separation between LLC records and personal records - Can't produce organized financials by property/LLC
Why it's fatal:
Courts require LLCs to maintain "corporate formalities"—treating the LLC as a real business entity separate from you personally.
Poor record keeping = evidence you didn't treat it as a separate entity.
In a lawsuit:
Discovery requests typically include: - "Produce annual financial statements for the LLC for the past 3 years" - "Produce meeting minutes documenting major decisions" - "Produce bank statements showing separate accounts maintained" - "Produce evidence of separate record-keeping"
If you can't produce these, the plaintiff argues: "Your Honor, no real business would operate without basic records. This is a sham entity."
Courts agree.
What you need to maintain:
Minimum requirements: - Separate bank account for the LLC (absolutely essential) - Monthly bank statement reconciliation - Annual financial statements (even simple P&L and balance sheet) - Annual "meeting" even if just you (document major decisions in writing) - Separate files for LLC documents (operating agreement, formation docs, tax returns)
Better practice: - Accounting software with separate file/profile for each LLC - Quarterly financial review - Written documentation of all major decisions (property purchases, large expenses, loans) - Organized filing system for LLC records
Time required: 2-4 hours per year minimum
Value: Your LLC withstands "sham entity" challenge
Failure #5: Commingling Personal and Business Funds
The mistake: Using LLC and personal accounts interchangeably
What commingling looks like:
Using LLC account for: - Personal expenses (groceries, gas, personal credit card payments) - Personal loans to yourself (without documentation) - Expenses unrelated to LLC business - "Borrowing" from LLC when you need cash
Using personal account for: - Paying LLC expenses - Receiving LLC rent payments - Paying LLC property taxes or repairs
Transferring money freely between LLC and personal accounts without documentation
Why it's fatal:
Commingling is the #1 evidence that you don't treat the LLC as separate from yourself.
Courts reason: "If you treat the LLC bank account as your personal checking account, you're not maintaining any separation. The LLC is just an extension of you personally. It should be disregarded."
In discovery:
Plaintiff's attorney reviews your LLC bank statements and finds: - Walmart charge (personal groceries) - Chevron charge (personal gas) - Personal credit card payment - Transfer to personal account labeled "loan" (with no promissory note) - Personal insurance payment - Kids' school tuition
Plaintiff's motion: "Your Honor, the defendant uses this LLC account as a personal checking account. This is not a legitimate business entity."
Judge reviews bank statements: "Motion to pierce the corporate veil granted."
The fix:
Absolute rules: 1. LLC has its own bank account, used ONLY for LLC business 2. Personal accounts are used ONLY for personal expenses 3. Never pay LLC expenses from personal accounts 4. Never pay personal expenses from LLC accounts 5. Money only moves between LLC and personal via proper distributions or documented loans
If you need to take money out: - Take a formal distribution (documented, recorded in LLC books) - Or make a loan from LLC to yourself (promissory note, interest, repayment terms, actually repaid)
If you need to put money in: - Make a capital contribution (documented as increasing your capital account) - Or make a loan from yourself to LLC (promissory note, actually repaid)
This separation is non-negotiable.
One of the fastest ways to destroy LLC protection is sloppy account management.
Other Ways LLCs Can Fail (There Are More)
These are the five most common failures. But there are other ways LLCs can fail:
- Inadequate capitalization (LLC has no money to operate) - Using LLC to commit fraud or illegal acts - Ignoring LLC formalities (never holding meetings, no member votes) - Failing to maintain separate identity (using "I" instead of "the LLC") - Operating outside the LLC's stated purpose - Transferring assets to LLC after lawsuit filed (fraudulent conveyance)
The point: LLC protection isn't automatic. It requires proper formation AND proper ongoing maintenance.
The Pattern: DIY LLCs That Fail
Here's the common pattern:
Year 1: Investor forms LLC online or with LegalZoom - Certificate of Formation filed ✓ - Operating agreement downloaded but not signed ✗ - Properties still in personal name (forgot to transfer deeds) ✗ - Separate bank account opened ✓
Year 2-3: Investor operates properties - Uses LLC account for business expenses ✓ - Also uses LLC account for some personal expenses ✗ - No financial statements prepared ✗ - No meeting minutes created ✗ - Still hasn't transferred deeds ✗
Year 4: Investor gets sued - Confident the LLC will protect them - Discovery reveals all the failures above - Plaintiff moves to pierce corporate veil - Judge agrees—veil pierced - Investor loses personal assets
The investor didn't intentionally do anything wrong. They just didn't know what they didn't know.
The Questions You Should Be Asking
If you have an LLC (or are considering forming one), ask yourself:
Operating Agreement: - [ ] Do I have a written operating agreement? - [ ] Is it signed by all members? - [ ] Where is the executed original kept?
Property Ownership: - [ ] Are my properties actually deeded to the LLC? - [ ] Can I produce deeds showing LLC ownership? - [ ] Are the deeds properly recorded with the county?
Annual Compliance: - [ ] What annual filings are required in my state? - [ ] Have I filed everything required? - [ ] Is my LLC in good standing (not administratively dissolved)?
Record Keeping: - [ ] Can I produce financial statements for my LLC? - [ ] Do I have any meeting minutes or decision documentation? - [ ] Are LLC records separate and organized?
Account Separation: - [ ] Does the LLC have its own bank account? - [ ] Am I using it ONLY for LLC business? - [ ] Have I ever used it for personal expenses? - [ ] Do I have proper documentation for any transfers?
If you answered "no" or "I don't know" to any of these, you have vulnerabilities.
Don't Wait Until You're Sued
The time to fix LLC problems is now—before you need the protection.
Once a lawsuit is filed: - It's too late to create an operating agreement (courts see this as fraudulent) - It's too late to transfer deeds (fraudulent conveyance) - It's too late to start maintaining records (obviously retroactive)
Asset protection must be in place BEFORE claims arise.
Does Your LLC Actually Work?
Most investors assume their LLC works. They have a Certificate of Formation. They feel protected.
But when will you find out if it actually works?
When you pull the ripcord. When you're being sued. When it's too late to fix it.
That's my policy on discount parachutes—and discount LLCs.
Free LLC Health Check:
Let me review your LLC structure: - Do you have the 5 common failure points? - Are there other vulnerabilities? - What can be fixed now (before you're sued)? - What compliance are you missing? - Is your structure optimal for your portfolio?
📞 Call: 512-464-1110 📧 Email: david@pcfo.net 📅 Schedule: Book free LLC review
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About David Disraeli: 40+ years protecting Texas investors. 180+ Series LLCs formed. 385+ properties protected. A+ BBB rating. Specializing in Texas real estate asset protection and ensuring your LLC works when you need it.