New Lawsuit Protection from Limited Liability Companies (LLCs)
A recent decision* in the Appellate Court of Illinois has provided a new reason to consider using a limited liability company (LLC) as your business organization of choice. LLCs beat out corporations now in some important ways.
Consider business organizations in general. Partnerships and limited partnerships provide very little liability protection, so we turn to corporations and LLCs. Think of either as a “company” for the moment. State law gives people the ability to create a company so that multiple people can pool their resources and start and run a business. Imagine Al, Bob and Carl have an idea for a great new tractor. They don’t have enough money to build a factory, buy the tooling and hire the workers to start producing and selling this new tractor. But they convince forty seven of their friends that they have a good idea, and they create ABC Company. The fifty people each invest $50,000, for a total of $2,500,000. Each of the fifty investors receives a certificate saying he is a shareholder: he owns 2% of the company. One could estimate the value of the investor’s shares at $50,000 since they represents 2% ownership of a company that holds $2,500,000 in assets. The shareholders elect officers to run the company. The officers use the $2,500,000 to build and equip the facility and hire the workers to produce the tractors.
If the company is successful, it makes a profit to be distributed to the shareholders. If not, all of the shares drop in value. One way ABC Company could lose money is through some terrible accident. Tom, a company employee, is delivering one of the new tractors, falls asleep at the wheel and crashes into an electrical substation, disrupting power to half a city and causing personal injuries. The lawsuits result in claims of $20,000,000 against Tom, since he was the driver a fault, and his employer, ABC Company. Tom files personal bankruptcy and his life goes on. How about ABC Company and the fifty shareholders?
The bad news is, ABC Company is bankrupt, too. All the equipment and facilities are sold, and the money spread among the lawsuit claimants. The value of each investor’s shares went to zero. Their investments of $50,000 each have been lost. But there is good news. None of the shareholders are personally liable. They can only lose what they invested in the company. They can’t be held personally responsible, sued and forced into personal bankruptcy.
This illustrates the liability limitation given by state law to encourage people to organize their resources to start businesses. It applies to both corporations and LLCs. But LLCs go a step further.
What if instead of Tom, who is a mere hourly employee, it was Carl driving the delivery truck? Carl is one of the shareholders (he invested $50,000 like the others) and he is part of the management team of ABC Company. Since the Company goes bankrupt, he loses his $50,000 investment. But does he get sued personally, like Tom would if he caused the accident?
If ABC Company is a corporation, Carl gets sued personally. He was the driver who caused the accident. So he not only loses his $50,000 investment in the company, but he would also lose his home, personal savings and most of the rest of his personal assets.
However, if ABC Company is an LLC and has been established with the right documentation, Carl is not going to be personally sued. The company can be wiped out, but the lawsuits cannot reach beyond the company assets. They cannot lay claim to his personal assets. Why? Illinois law which permits the formation of LLCs says “the debts, obligations, and liabilities of a limited liability company, whether arising in contract, tort, or otherwise, are solely the debts, obligations, and liabilities of the company. A member or manager is not personally liable for a debt, obligation, or liability of the company solely by reason of being or acting as a member or manager.”
If you are forming your own closely held business, maybe with just one shareholder or with only two or three (perhaps you, your spouse and one child) and you are Carl, not only a shareholder but also actively managing and working in that business, look at LLCs for maximum liability protection.
One final note. An LLC is a way of restructuring, or formally organizing, what you own to help protect what you have while living. But don’t be confused by someone who asks, “which is better, an LLC or a living trust?” That is like asking, “which is better, corn or a grain cart?” An LLC is no substitute for a living trust. If you form an LLC, that company will be something that you own (like corn), but a living trust would specify who will receive it upon your death (transports the corn). A carefully created living trust can also provide many asset protection
and long-term transfer tax
benefits for the people who receive it upon your death. But those are topics for another day.
*Dass v. Yale
Article authored by Curt W. Ferguson and originally published in the Prairie Farmer magazine, August 2014 issue