The single member limited liability company is a business entity shrouded in a cloud of mystery when it comes to liability protection for the sole member. There is conflicting information on the web as to whether the single member LLC provides protection or no protection to the owner.
Why do you form a business entity? For most people, the reason is to create a shield of protection between the liabilities and debts of the LLC and their assets. For others, the purpose is to use the entity as part of an asset protection or estate plan. A single member LLC provides protection in the first instance in most cases, but rarely the second case. Let’s focus on the first instance for the purpose of this article.
Business Debts and Liabilities
You decide to launch a website selling lampshades for people to wear at parties. You make the wise choice to set up a limited liability company since booze will be present. As the only owner, the law designates a single member limited liability company automatically. The owner of an interest in a limited liability company is called a “member,” and the owner will create an operating agreement to govern the operation of the company. [Learn why an operating agreement is essential.]
So, does this business entity provide you with protection from lawsuits and business debts? Yes…and no.
An LLC will protect you from liability claims arising from business operations so long as you set it up, capitalize it, and run it correctly. For example, let’s assume we move forward with the lampshade website. The business does well, but an idiot attempts to drive his car while wearing one of our lampshades. He crashes and sues the company. In this scenario, he can only sue the LLC. You, the single member, are protected. However, this is not the end of the story.
In certain situations, the single-member LLC will provide you with no protection. No protection exists where you are personally involved in the disputed action and sued as an individual based on the involvement. As always, an example can show how this might play out.
Let’s assume you run into a problem with your inventory. The Chinese company making your lampshades is 45 days behind schedule. Facing dwindling stock, you decide to drive two hours to a wholesaler selling similar lampshades. You fall asleep at the wheel and cause an accident. Numerous people are seriously injured.
Technically, you are on a business trip and can argue only the company should be sued in the matter since you were acting as an employee on the drive. This argument will fail. The injured parties will be able to sue the LLC AND you personally because you were personally involved [driving]. This double defendant situation is often referred to as “top-down” liability by attorneys. Let’s take a look at another example to be sure you have the concept down.
I have good news. The lampshade website is a tremendous hit. You decide to open retail stores in malls. Customers, however, can be annoying. One day, an employee gets fed up and takes a swing at a customer. Three days later, you do the same thing.
In this example, the customer punched by the employee can only sue the LLC. You, the single owner, will be protected by the LLC shield. The potential debt is purely the responsibility of the LLC.
Now we turn to your punch. In this situation, the customer can sue you directly because you threw the punch. Your personal action gives rise to potential liability, and the LLC will provide no protection.
The lesson from all this is to make sure you set up and correctly run the limited liability company. If you are paying $99 to get it set up, you are asking for trouble with issues such as capitalization.
Assuming you do set the entity up correctly, it is vital you conduct all business under the name of the company. All contracts should be in the name of the LLC. Avoid any personal guarantees. The company should also own the website domain.
If you need assistance with a California limited liability company, feel free to contact me for a consultation.
Richard A. Chapo, Esq.