Can an LLC Member take out a Loan against a Property? (Corp. Code § 17704.06)

By Underwood Law Firm

Under California law, an LLC member’s ability to take out a loan against an LLC-owned property depends on several important factors. Many LLCs explore this strategy as a means of freeing up capital without selling valuable LLC assets. Understanding the limits and permissions involved is crucial before pursuing this type of financing. 

What is an LLC?

Limited Liability Companies (“LLC”) combine characteristics of corporations and partnerships to create a unique hybrid business entity. (Corp. Code § 17701.01 et seq.) By design, LLCs provide members certain protections similar to those available to shareholders of a corporation. Therefore, LLC members are generally immune from personal liability for the LLC’s debts or obligations. (People v. Pacific Landmark, LLC (2005) 129 Cal.App.4th 1203, 1213.) 

Legally, an LLC exists separately from its members. (Corp. Code § 17701.04.) Accordingly, an LLC has broad powers under the California Corporations Code, which may not be available to members themselves. These statutory powers allow the LLC, as an entity, to borrow money, pledge assets, and transact businesses. (Corp. Code § 17701.05.) For example, the LLC may pledge, encumber through a mortgage, dispose of, or otherwise manage its property, but the LLC’s members generally cannot. (Id.) 

LLC Members

The relationship between an LLC and its members is governed by the LLC’s articles of incorporation and operating agreement. 

An LLC’s operating agreement is the legal document which outlines the LLC’s structure, internal governance, and operational rules. (Corp Code § 17701.02.) Essentially, an LLC’s operating agreement is a contract which binds LLC members and details their rights, responsibilities, and obligations to the LLC and each other. (Id.) The operating agreement may also address issues such as distribution of profits and losses, management structure, and provisions for amending the agreement itself. (Id.) 

Members may adjust an LLC’s structure and internal governance in the operating agreement to better serve the LLC’s specific circumstances. (see Samuelian v. Life Generations Healthcare, LLC (2024) 104 Cal.App.5th 331.) For instance, LLCs are member-managed by default; meaning that the law presumes the LLC’s members will assume responsibility for the control and management of the LLC’s operations. (PacLink Communications Internat., Inc. v. Superior Court (2001) 90 Cal.App.4th 958, 963.) However, the LLC’s operating agreement may specify a manager-managed structure instead. (Id.) In comparison, designated managers are responsible for the controlling and managing the LLC’s operations. (see Swart Enterprises, Inc. v. Franchise Tax Bd. (2017) 7 Cal.App.5th 497.) Thus, in a manager-managed LLC, members have no authority to decide matters related to the LLC’s activities. (Corp. Code § 17704.06, subd. (c)(1); Swart Enterprises, Inc. v. Franchise Tax Bd. 7 Cal.App.5th at 510.) Instead, members only have the ability to remove a designated manager from their position through a majority vote, as designated in the operating agreement. 

Accordingly, an LLC’s operating agreement may provide specific procedures that members must follow when acting on behalf of the LLC in various different circumstances. 

Can an LLC Member take out a loan against LLC owned real property?

Importantly, the legal significance of an LLC means that each member’s interest in the LLC is personal property. (Kwok v. Transnation Title Ins. Co. (2009) 170 Cal.App.4th 1562, 1570.) This also means that LLC members have no interest in the LLC’s specific property. (Id. see also PacLink Communications Internat., Inc. v. Superior Court (2001) 90 Cal.App.4th 958, 964.) As such, LLC members generally cannot take out a loan against property owned by the LLC itself, because members do not have a direct ownership in the property. 

However, members may obtain authorization to undertake a loan against LLC owned property if the operating agreement establishes the right, and procedures for obtaining authorization to do so. More specifically, because operating agreements outline the LLC’s operational rules, the process members must take to obtain member consent for significant actions are outlined in the operating agreement, if the procedures exist. 

For example, in Sam v. Kwan (2024) 101 Cal.App.5th 556, the court reiterated that operating agreements are essential for verifying the consent of LLC members to property sales. Therefore, it follows that an LLC member must follow the proper procedure for obtaining member consent as outlined in the operating agreement, if they wish to take a loan out against LLC property, in their individual capacity. 

If a member fails to obtain proper authorization from the LLC to undertake the loan, California law vests LLCs with authority to ratify actions taken on its behalf because LLCs possess the same powers as a natural person when carrying out business activities. (Corp. Code § 17705.05.) An LLC performs the act of ratification when it authorizes a member to perform an act, such as undertaking a loan against LLC property, after the action has been performed. (Camden Systems, LLC v. 409 North Camden, LLC (2024) 103 Cal.App.5th 1068, 1080.) However, any action taken without proper authorization, which the LLC does not ratify, is unenforceable against the LLC. (Western Surety Co. v. La Cumbre Office Partners, LLC (2017) 8 Cal.App.5th 125.) 

Ultimately, the operating agreement dictates whether an LLC member may undertake a loan in their individual capacity, against LLC property. When an operating agreement allows members to take loans out against LLC property, members must ensure they follow the proper procedures to protect themselves, their loan, and the LLC. Absent an applicable provision, LLC members generally cannot take a loan out against LLC property. 

What is an Example?

“Shawn” and “Julie” are the only members of a member-managed LLC, which owns one piece of real property. Julie is in the process of buying a house and needs to take out a loan secured by the LLC’s property. After discussing the matter with Shawn, Shawn agrees to authorize Julie’s loan, as required by the operating agreement, and Julie is able to obtain her loan. 

Months later, their LLC’s business dwindles, and Shawn and Julie disagree on how to handle Julie’s debt. Julie wants to refinance to avoid the risk of losing her home; Shawn, however, refuses, and instead demands that Julie agree to sell the LLC’s property and dissolve the LLC after. Unable to reach an agreement, Shawn files an action for partition of the LLC property, seeking a court-ordered sale which will allow Julie loan to be repaid before distributing the remaining sale proceeds between Shawn and Julie. 

Conclusion

In sum, a careful review of California law and your LLC’s operating agreement will ensure any loan taken out against LLC owned property is both lawful and strategically sound.

For more information on this or other Real Estate Law topics, visit the website for the Underwood Law Firm. Elijah Underwood operates California’s Number 1 Partition Law Firm, with experience handling partition trials and complex partition actions including multiple properties, multi-family, industrial, commercial, and million-dollar properties. His firm is currently handling around 200 partition actions throughout California, and he is considered by many to be the foremost expert on partition law in California. Mr. Underwood is a graduate of UC Law SF, and UC Santa Barbara.