Entrepreneur Emmett Dulaney
The Limitations of Limited Liability You may have more exposure than the name suggests
The Limited Liability Company (LLC) is one of the most popular types of business entities. Among its attractions: it’s easy to set one up (you can fill out the forms online at www.in.gov). But many are drawn to the promise of that title – “limited liability.” In fact, if you look at the Frequently Asked Questions on the Indiana Department of Revenue site, you’ll find the following definition (I added the underlines for emphasis): Limited liability company (LLC*) – A business structure that blends some characteristics of a partnership and a corporation. Liabilities are limited to the owner’s agreed investment in the business. A LLC is an entity formed under state law by filing articles of organization. None of the members of an LLC are personally liable for the business’s debt.
There are a number of situations where the veil can be pierced and they almost always involve some form of negligence… Most of the time the underlined phrases are accurate, but to not acknowledge situations where they fall apart can be disastrous. These misconceptions are not limited to LLCs – they exist with other forms of business entities as well - but I am focusing on the LLC since the name holds
8
such attraction for entrepreneurs starting new ventures. In all circumstances, however, you should rely on the advice of a legal professional to get the most precise information for your business, and the specifics listed here are meant only as guidelines. The best way to illustrate shortcomings with the definition is with an example. Imagine I walk away from my day job and decide to finally follow my passion by starting Dulaney Computer Service, LLC. Instead of going with a sole proprietorship for my one-man company, I opt to register with the Secretary of State as an LLC because I want the limited liability protection that will keep someone from going after my personal assets should a problem occur, and I want the business to be responsible for debts instead of me personally. Due to space constraints, we’ll limit the number of DCS’s limited liability cracks to two.
Crack #1: Piercing the Corporate Veil
The very first day of business is promising. Mike Corbett calls and hires DCS to upgrade all the existing Hamilton County Business Magazine PCs to Windows 7 and install faster network cards. With a spring in my step, I walk in with my toolbox which contains the only two tools anyone needs: a hammer and a cordless reciprocating saw. After the third PC refuses to boot following the upgrade, Mike begins yelling that I don’t know what I’m
February • March 2011/Hamilton County Business Magazine
doing and I need to leave now. In order to keep the peace, I tell him that I won’t charge him for the rest of the day, but that fails to comfort him and he files a lawsuit against the company. I smile believing that the only restitution he will be able to receive, should he even win the lawsuit, will be limited to assets of DCS (thanks to limited liability) and there currently aren’t any assets there. My feeling of protection is false. Since the company and I are one and the same, and the harms were caused by my lack of ability (“negligence” is what the courts would call it), the corporate veil can be pierced and I am personally liable for damages. There are a number of situations where the veil can be pierced and they almost always involve some form of negligence: negligence in action, negligence in hiring, negligence in managing, etc.
A good overview of legal issues facing the entrepreneur can be found in Daniel Davidson and Lynn Forsythe’s The Entrepreneur’s Legal Companion (ISBN: 978-0-13-607723-7). While not delving deep into any individual topics, it provides a good skeleton of subject matter to be cognizant of when forming the new venture.