The single member LLC is one of the more popular choices for small businesses. It is often touted as the perfect business entity, but there are definitely some areas of concern that a person forming the entity should know about. One has to do with the issue of piercing the corporate veil.
Why would you form a single member LLC? The answer is found in liability protection. If the business is sued for negligence or unpaid debts, then the individual that owns the entity will not be personally liable. This singe owner is known as a “member”. While the LLC provides the asset protection of a corporation, it requires very little paperwork to be done by the member. This combination of factors makes the entity popular with small business and real estate investors.
The single member LLC does come with a few downsides. Tax issues can arise, for instance. There is a far more subtle issue that also exists that is rarely talked about. It has to do with the actual viability of the single member LLC as an asset protection tool. To under the issue, we first have to look at how entities are attacked.
The LLC provides its owners with a shield or veil against liability. Plaintiff attorneys will then seek to “pierce the corporate veil”. This is done by showing the LLC is a sham. How does an attorney do that? Well, they take out the rules and regulations of the company and see if the member has been complying with them. This is where things get ugly for many single member limited liability companies.
The rules and regulations of the LLC are found in the Operating Agreement. This document is the equivalent of the bylaws of a corporation. The good news is the typical operating agreement for the LLC does not require the member to do much. The bad news is most single member LLCs have the wrong operating agreements that can result in sham claims being found credible by a judge.
The problem is found in the formation of the LLC. Many people use the inexpensive online services. Those services file the formation documents, but only supply the new owner with a sample operating agreement. These samples are written for LLCs that have multiple members. As such, the agreements call for meetings, voting procedures and a host of other processes. The single member owner cannot comply with these rules for the simple reason that there are not multiple people involved. For instance, how do you have a meeting with only one person? How about a committee? Do you stand in front of a mirror?!
Now imagine how an attorney is going to present this to a judge. “Your honor, this LLC is such a sham it isn’t funny. How do we know? This is a single member LLC that has an operating agreement for a different type of business entity! Your honor, we can’t even discuss whether the defendant followed the operating agreement because he never bothered to get an applicable one! The LLC must be set aside and the defendant should be found personally liable for this claim.”
This is a situation that you really do not want to find yourself in. A judge may very well decide against you. Not only have you not complied with the requirements of your LLC, you don’t even have them! That is a disaster in any courtroom.
The single member LLC is a viable and legal entity. That being said, it is absolutely critical that you set it up correctly. The courts will recognize there is opportunity for abuse since there is only one shareholder. As a result, they will look closer at the entity than they will with others. Make sure you have yours in order or you may be found personally liable for its debts.