Limited liability companies can guard personal wealth

Every month our firm gets calls from parties seeking to set up a limited liability company. However, many of these people cannot tell us why they want to form such an entity; usually it’s just something they have been told to do to or have heard of others doing.

We try to explain to them that forming a business entity (be it a corporation, LLC, limited partnership, limited liability partnership or some other variation) is frequently a good idea for a business owner, but that doing so has advantages and disadvantages. More important, we try to advise them about how they can minimize the disadvantages and maximize the advantages.

The key advantage to a business owner in forming an LLC is limiting the liability of the owner for the business’ debts and obligations. If an owner operates a business as a “sole proprietorship,” or one or more owners operates a business as a “general partnership,” the owner is personally responsible for all of the liabilities of the business, be it rent, payroll, invoices for inventory, or even a judgment or administrative penalty.

However, if the owner forms an LLC, that entity becomes a legally recognized “separate person,” and the liabilities of the LLC are not imputed to the owner. By moving all of the business assets into and operating the business through the LLC, the owner’s personal assets (other than his or her equity in the business) are protected from any creditors of the business and not subject to collection if the business defaults on its obligations. This is potentially valuable to all business enterprises, but particularly important in fields where the risk of incurring significant liability is high.

There is more to obtaining and maintaining this level of protection than simply forming an entity (which is done rather simply online with the secretary of state’s office). A business owner must also be cognizant to always run and treat the business entity as a legitimate separate party and not as his or her “alter ego.”

Colorado courts will disregard the premise of limited liability if the owners “disregard of the corporate entity made it a mere instrumentality for the transaction of their own affairs” and where “there is such unity of interest and ownership that the separate personalities of the corporation and the owners no longer exist.” In short, if you create an entity to run your business, you can’t run your personal affairs through the entity as well. Doing so creates a risk that a creditor could “pierce the corporate veil,” convincing a court to make the owner responsible for the business’ obligations.

What factors does a court look at in determining if an entity has been operated as a party’s alter ego? The biggest issue is usually the intermingling of money, i.e. the use of business money to pay personal expenses. In short, an LLC should have a separate bank account, and that account should only be used for doing the business of the business – not for paying the owner’s mortgage. Owners can pay themselves as employees and/or take distributions or draws from the entity, but there should be a sharp line separating personal and business affairs.

The owner should also be certain that all documents be signed and all business conducted in the entity’s name and not his or her own. If there is more than one owner, corporate formalities should be observed such as drafting an Operating Agreement and executing member consents for company actions. All business assets should be owned and titled to the entity, or subject to legitimate written lease agreements with the owners.

Finally, the services and advice of a good accountant should not be disregarded. In this way, you can be sure that your LLC is not just properly formed, but also properly fed and watered to maintain its defenses for your personal assets.

Douglas Reynolds practices civil litigation and criminal defense at the Bopp Reynolds Law Group. He can be contacted at 259-0661 or drey@boppreynoldslaw.com.

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