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LLC's Limited Liability Protection
Limited Liability Companies (“LLCs”) are a very popular business entity used by many individual for business and for investment purposes. The reason for using an LLC is that the LLC provides a lot of flexibility in the operating of the business and most importantly provides limited liability protection.
What is Limited Liability?
Limited Liability in the context of an LLC can be inside or outside. Inside limited liability protection applies to the acts of the limited liability company. Outside limited liability protection applies for act of the members who own the LLC, and the ability of the member’s creditors to attack the LLC.
For example, contracts and services provided by the LLC are inside protection. Therefore, if the LLC breaches a contract or provides a bad service and the person brings a claim against the LLC for wrongdoing, the injured party only remedy are the assets of the LLC.
Outside limited liability protection involves protecting the LLC from the wrongdoing of its members outside of the LLC activities. For example, one of the Members gets into a car accident and the injured party suffers extensive damages. If the Member does not have sufficient individual assets to over the loss, the injured party may attack the member’s interest in the LLC to remedy the damages.
Now that we know what inside and outside limited liability protection is for an LLC, lets cover how a creditor of the LLC or your personal creditor can attack the LLC or you personally to remedy their damages.
Attacking inside limited liability protection
Like I mentioned before, the LLC’s creditors are limited to the assets and profits of the LLC for any wrongdoing. Some times is the case where the LLC has no assets and a small amount of income to cover the damages by the creditor.
If the damages are substantial, then the creditor might attempt to “pierce the corporate veil” to remedy the damages. Piercing the corporate veil is a legal term derived with Corporations, but it has been applied to an LLC.
In order to pierce the corporate veil the creditor must usually show that (1) the LLC independent existence was non-existent and the members were in fact alter egos of the LLC; (2) the LLC was used fraudulently or for an improper purpose; and (3) the fraudulent or improper purpose use of the LLC caused injury to the creditor.
This is actually very difficult to do and courts are reluctant to pierce the corporate veil and make the members personally liable absent fraud or an improper purpose. One of the main things to get from reading cases and past disputes is that you must be respectful of the entity form. If you have an LLC and you are doing business as such, respecting the formalities of the LLC is of utter important and not treat the LLC as a mere sham.
Attacking outside limited liability protection
As mentioned above, outside protection involves the LLC’s ability to protect itself from any wrongdoing by its members.
In Florida, the owners of an LLC are called Members. The LLC can either be a single-member LLC or a multi-member LLC. The Florida Revised Limited Liability Company Act (the “Act”) makes an important distinction between single-member LLC and multi-member LLC.
For multi-member LLC’s, the Act makes a charging order the sole and exclusive remedy for a creditor’s right against a member’s interest in an LLC. A charging order constitutes a lien upon the member’s transferable interest and requires the LLC to pay over the judgment creditor a distribution that would otherwise be paid to the member.
What does this mean? The charging order only allows the creditor to get distributions, losses, or creditors that the member was entitled. Therefore, if the LLC pays a distribution to the member, the creditor of the member would be entitled to that distribution, BUT the creditor will not be a part of the LLC or will be able to foreclose on the interest of the member.
The law protects the other members that were not involved in the wrongdoing and do not want an outside person who may not have any knowledge in the business to run the affairs of the company.
Compared to a multi-member LLC, a single-member LLC has far less protection in Florida. If the creditor can prove in court that the distribution under the charging order will not satisfy its judgment within a reasonable time, the court may allow the sale of the interest in the LLC in a foreclosure sale.
If the court is satisfied and orders a foreclosure sale, the purchaser becomes the new member of the LLC and you cease to be a member of the LLC.
What is the takeaway?
I covered both inside and outside limilited liability protection. As you can see, limited liability is not absolute.
First thing to do is to talk to a business attorney and make sure that the house is in order. This means that you are running your LLC properly and have all the required documents required by state law.
Your LLC is a business entity and thus should be respected. Use the LLC for its proper business purpose and do not commingle your personal affairs with those of the LLC.
There are ways to make a single-member LLC into a multi-member LLC. Depending on the circumstances, adding a spouse or a separate company to become the second member is sometimes recommended. There are more ways to add a member to a single-member LLC but you should first consult a business attorney so he or she can analyze your particular facts and circumstances.
As always, this is not meant to be legal advice, but only for informational purposes. You should always consult to a licensed attorney for specific advice tailored to your situation, and this article does not create an attorney-client relationship.
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