Limited Liability

This is the fourth and final article on the corporate elements you choose from when setting up an LLC.  The four are centralized management, continuity of life, transferability, and limited liability.  Here we will be talking about the most important of these, limited liability.

Limited liability is the name of the game in corporations and LLCs.  Limited liability doesn’t mean “free from all responsibility.”  It is LIMITED liability, but it is the best shield you can get to protect the founders, officers/directors, and managers of LLCs and corporations.

Technically, when you establish an LLC, you should only pick two of the four corporate elements.  Obviously, limited liability will be one of the two choices.  Note that it is the same corporate shield that corporations have.  It is the same protection.  It protects the owners (members) and managers from liabilities that arise in the LLC through acts done by employees (including you when acting as an LLC employee or manager).

LLCs are creations of each state.  Each state has different rules and regulations. Most states have adopted the Uniform LLC Act of 2006, so their laws are pretty similar.  The concept is that the LLC is supposed to offer a liability shield, but not be as complicated as the corporation, so some believe you can simply set up an LLC and the protections come automatically.  This belief is largely a myth, especially because some states have specific laws that say that the liability shield will not be in effect if the formalities of maintaining a corporation are not followed.

The argument people use to pierce the corporate veil in a corporation or an LLC is basically the same, and the defense is the same.  The argument is that the owner of the closely held company is actually using the entity as his or her “alter ego.”  This means, more or less, that the guy suing the company doesn’t have to recognize the limited liability shield, because the owner has treated it as an extension of himself rather than an independent entity.  If the owner didn’t treat the company as a real company independent of himself, then why should the courts treat it as a real company?

The way you show the court that you did in fact treat the company as an independent entity is to show the court that you have followed the corporate formalities.  Did you commingle money?  (That’s the big one.)  Hold meetings?  Issue membership/stock to the owners?  Write and follow your bylaws/operating agreement?  Show that your creditors recognized they were dealing with an independent entity and not just you as a person?  Paid your state fees and filed the proper papers with the state?  I’ve got a 27 point checklist for these corporate formalities.  For a free copy, sign up here.

The LLC has the same corporate shield aka limited liability as the corporations do. However, the LLC also has charging order protection, which has nothing to do with limited liability, but is just as important. The logical conclusion, and the right conclusion in most circumstances, is to use an LLC instead of a corporation. One exception is if you need more than two of the four elements of a corporation in your company structure. If you need more than two of the elements, you had better strongly consider using an actual corporate structure instead of an LLC structure.