Limited Liability Companies (LLCs) were born in the mid-1980s out of a reaction to the inability to have a liability shield on a company that was not a corporation. These LLCs began making their way into state statutes across the country when the legislatures wanted to create an entity with a partnership-type structure but without the taxation of a corporation. Limited Partnerships did exist, but had the drawback that each of the active participants of these ventures was a general partner and was exposed to the debts of the partnership. Various workarounds were created, but none of the workarounds really addressed the fundamental problem: limited liability for those involved in the business.
I am often asked what limited liability means and how far it extends. It is important to note that limited liability does not extend to, and does not mean, protection from creditors resulting from an owner’s own actions. If the owner runs someone over in the crosswalk, it does not matter that there is a company set up – the owner cannot shield himself/herself from creditors for something he or she personally did. However, if it was a company employee that ran someone over in the crosswalk, the victim would be able to sue both the employee and the company if the action was done within the scope and furtherance of the employee’s employment. This means that the company is liable. If there are insufficient assets in the company, then the victim is out of luck. The owner of the company is liable only to the extent that he or she has invested in the company.
The Role of Insurance
As far as liability goes, insurance should always be the first line of defense. When discussing the liability aspect of a company, the company should always have insurance and the owner should carry as much insurance as he or she can afford. This also includes umbrella insurance. To use a baseball analogy, the insurance is the catcher and anything that gets by the catcher will be stopped by the backstop, the backstop in this analogy being the Limited Liability Company. If the owner is safely behind the backstop then he or she can never be hit by the wild pitch, and all that it is at risk is his/her investment. However, if the owner is the one responsible for the action then he or she can be held liable.
Insurance does more than just pay claims; insurance also defends against lawsuits. Sometimes the lawsuits are frivolous and they are dismissed outright. It takes a lawyer acting on your behalf to make this happen. The insurance pays for this lawyer. Sometimes the matter must be submitted to a court to determine what happened. Again, the lawyer is paid by the insurance company to ensure that the exposure to damage is minimized.
Types of LLCs
There are two general types of LLCs: manager-managed LLCs and member-managed LLCs. A manager-managed LLC looks a bit like a corporation (or limited partnership). In dealing with the manager-managed LLC, only a manager has the authority to bind the company in a contract. Just as officers in a company have signing authority for the company, general partners also have signing authority for a limited liability company whereas shareholders and limited partners and members do not have this signing authority.
A member-managed LLC looks just like a general partnership in that any member can bind the company in a contract. In a general partnership, each of the partners is jointly and severally liable for the actions of the other partner or partners, which means that one partner’s actions could have a substantial effect on the personal financial situations of the other partners. Not so in an LLC. Only the assets that are in the company are at risk.
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