Limited Liability Companies

Limited liability companies (known as “LLCs”) are relatively recent additions to the laws of most states. They are designed to be flexible like a partnership, but to provide a more well-defined structure and greater personal liability protection, while being easier to operate than corporations

So what is a Limited Liability Company and how is it formed?

A limited liability company (known as “LLC”) requires formal creation with the state by filing the Articles of Organization with the office of the Secretary of State, which usually costs around $100. Some states also require an operating agreement to be filed. Even when not required, it is recommended to have an operating agreement for an LLC. Unlike a sole proprietorship or general partnership, an LLC cannot be established simply by actions or default. This entity must be intentionally desired by the business owner and created through paperwork with the state.

What are the features of a Limited Liability Company?

LLCs are incredibly flexible.  While they have a set of default rules like every other business entity, the vast majority of those rules can be changed by the owners of the company.  This makes LLCs a very attractive option for many businesses.

The owners of an LLC are known as “members,” and, like partners, can have complete authority over the operation of the business.  But not all LLCs are run by all of the members: LLCs have the option of being considered “member-managed” or they can be “manager-managed” LLCs, where the control over the day to day operation of the company is turned over to a specific individual (or group of people). There are several key differences between manager-managed and member-managed LLC’s.  For example, in a member-managed LLC there is no separation of ownership and control. In contrast, in a manager-managed LLC the managers have control and the members do not (unless the manager is also a member). The difference has to do with the amount of day-to-day involvement of the members/owners. Furthermore, in a member-managed LLC, the default rule is equal voting rights for each member. In a manager-managed LLC, a majority of members vote on the managers and then managers have equal voting rights for the decisions, essentially adding an extra layer to the voting process. There are 12 types of business activity where all members receive an equal vote under the default rules where decision must be unanimous. The most important category is that no member can decide to sell all or substantially all of the LLC’s property with just the managers. Members must get a vote, as well.

Now let’s look at some other basic features of an LLC. Most importantly, in an LLC owners do NOT have personal liability for the debts and obligations of the company. Usually. But we’ll get to that later. In many ways, this is similar to the Limited Liability Partnership. However, similar to general partnerships, bringing in a new member to the LLC requires unanimous consent. Additionally, perpetual duration (where the LLC survives the departure of the owners) can be very complicated. Lastly, agency laws still apply for an LLC. An LLC is liable for loss or injury caused to a person as a result of a wrongful act or omission, or other actionable conduct, of a member or manager acting in the ordinary course of business of the company or with authority of the company.

What are your duties as a member?

Another key distinction between whether the LLC is member-managed or manager-managed has to do with the duties owed. In a manager-managed LLC, the other non-managing members DO NOT have fiduciary duties. The duty of care in an LLC is essentially the same as in partnership. It says the members must refrain from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of the law. This standard is beneficial because it is very high and rarely are members found to have violated the duty of care. The duty of loyalty is also the same as partnership. The benefit of an LLC is that you can have a company that is much less structured when it comes to formalities and rules (similar to partnership) but offers much more flexibility and protection from liability.

What if you don’t like the default rules?

Then you’re in luck, because with an LLC you can change almost all of them.  You can decide what types of action requires a majority vote by the members, or require some other number, like a two-thirds majority, or fifty-seven-point-five percent, if you think that is in the best interest of the company.  You can also decide to split up the profits of the company in a different ratio than the ownership of the business.  You can appoint officers, just like a corporation, so that you have a President or CEO, and even give each of those officers specific powers or authority to handle different aspects of the operation of the business.  

When is a member personally liable for the debts of the LLC?

The million dollar question: if an LLC is designed to protect the members from personal liability, how can a member become liable for the LLC’s debts? There are two ways a member can become liable. The most common way is to agree to be personally bound by a contract, or personally guarantee a debt or obligation. (See the “Signing Contracts” section of our Related Issues for an explanation of this. The other way is for a creditor or plaintiff to “pierce the corporate veil.” Piercing the corporate veil is a mechanism by which the liability protection of a business entity is stripped away and the individual member, partner, or owner is forced to pay the debt. This happens in corporations with a fair degree of regularity, but with LLCs it is harder to do. However, it can still happen. If you yourself do not treat your LLC as a separate entity, for instance, if you use your personal checking account for both the LLC’s operations and to pay your own bills, buy dinner, or get yourself a new set of golf clubs, it becomes much more likely that someone could hold you personally responsible for the debts of your business. Single-member LLCs are more susceptible to this than LLCs with multiple members, but it can happen to any of them, so please remember to follow all the necessary formalities, and whatever you do don’t mix your personal funds with those of your business!

Next: Corporations

© 2016 John V. Robinson, P.C.