Articles Posted in Limited Liability Companies

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Two recent conversations have reminded me of the importance of separating business enterprises for liability protection. I was helping a Sunnyvale real estate investor negotiate a commercial loan extension with a bank, and was thrilled that we had planned well in the past to separate all of his major properties into separate LLCs. It gave the bank a lot less power in negotiating against us – my client’s other properties were safe from this potential liability, but could be used as additional collateral if he chose to do so. At the same time, I was talking to a Mountain View manufacturing client about the risk of a potential employee lawsuit and realized that, due to some bad advice in the past that my client got from another advisor, he was holding real estate in the corporation thereby making the real estate subject to any liabilities of the company.

The example I often use is that each of your business enterprises or major assets is like a domino. Putting all of your dominoes in one entity means that a single domino falling can knock the others down too. Separating your dominoes into multiple entities means that if one entity is subjected to a lawsuit, the assets in the other entities should be insulated. Therefore, if my Mountain View client is faced with a large judgment on his employee problem, thanks to the appreciation in the real estate, the company looks like a really deep pocket.

Deciding how many entities to form, and how to separate your assets, is a complex cost/benefit analysis that depends highly on your level of comfort with risk. A good rule of thumb is to separate unrelated businesses (such as manufacturing and real estate, operating companies and investments). For real estate, consider grouping properties by the level of liability and the equity in each property, as well as the location of the properties. Also check with your professional advisors, such as your attorney and CPA, for liability, tax and insurance issues that could affect your decision.

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In my San Jose law practice, I often meet with clients who tell me they want to form a certain type of entity, and then proceed to tell me some facts that actually disqualify them from that form of entity. Even worse is when the client tells me that some other advisor told them they should be that form of entity. Recently, I met with a Cupertino real estate investor who said his financial advisor told him he should form an LLP for his property (he was not eligible to be an LLP). In Silicon Valley, we have a lot of do-it-yourselfers who form their own company online and then regret their ill-informed choice of entity and have to pay an attorney a lot more to fix the problem than they would have paid to do it right in the first place.

Here are some basic facts about LPs, LLPs and LLCs in California to help you make a more knowledgeable initial decision.

LP: This stands for “Limited Partnership.” In a limited partnership, at least one partner must be a general partner, which means that partner will be personally responsible for any liabilities of the partnership, as well as partnership decisions. The limited partners are not responsible for partnership liabilities, but also do not have any say in the management of the partnership.

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As usual, January is a time when people think about getting their business in order and consider the ‘choice of entity’ question. Already this month I have received calls from two contractors, one from San Jose and one from Sunnyvale, who want to form an entity for their construction business. I was able to give them the news that, as of January 1, 2011, the California Corporations Code finally allows a California limited liability company (“LLC”) to operate as a licensed contractor. However, the Contractors’ State License Board is only required to start processing applications no later than January 1, 2012.

For years, contractors were limited by a provision in the LLC Act that said an LLC may not “render professional services, as defined in Section 13401 and in Section 13401.3, in this state.” Sections 13401 defines professional services as “any type of professional services that may be lawfully rendered only pursuant to a license, certification, or registration authorized by the Business and Professions Code, the Chiropractic Act, or the Osteopathic Act.” In addition, a section of the Contractors’ State License Law provided for the issuance of contractors’ licenses only to individuals, partnerships and corporations.

As of this year, the LLC law was changed to add: “…a limited liability company may render services that may be lawfully rendered only pursuant to a license, certificate, or registration authorized by the Business and Professions Code if the applicable provisions of the Business and Professions Code authorize a limited liability company to hold that license, certificate or registration.” The Contractors’ State License Law was changed to allow for individuals, firms, partnerships, corporations, limited liability companies, associations, organizations, or any combination thereof.

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Since 1995 only attorneys, architects and accountants were eligible to practice as a limited liability partnership in California. However, as of September 30, 2010 new rules now allow engineers and land surveyors to take advantage of the LLP form of entity as well.

Although the law currently only extends until January 1, 2016, this is still great news for engineers and land surveyors that may have wanted a liability protection entity for their businesses, but did not want to deal with the hassle of annual meetings and minutes required of a corporation. These businesses are not eligible to be limited liability companies (LLCs) because of the restriction in the LLC Act preventing any business that requires a license or certification under the Business and Professions Act to be an LLC in California.

Section 16306(c) of the California Corporations Code provides in part that: “… a partner in a registered limited liability partnership is not liable or accountable, directly or indirectly, including by way of indemnification, contribution, assessment, or otherwise, for debts, obligations, or liabilities of or chargeable to the partnership or another partner in the partnership, whether arising in tort, contract, or otherwise, that are incurred, created, or assumed by the partnership while the partnership is a registered limited liability partnership, by reason of being a partner or acting in the conduct of the business or activities of the partnership.”

This liability protection is a very important reason to operate your business through an LLP.

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In Part 1 of this entry, I discussed problems that some of my Silicon Valley clients have had with improper choice of entity – either because the tax consequences weren’t considered, or because restrictions in the California Corporations Code or Business and Professions Code were not taken into account. Here are two more expensive mistakes that business owners make when they try to form their own corporation or LLC online.

1. Not doing the required securities filings.

Online sites may not tell you that if you fail to file California and/or Federal securities filings you could be in violation of securities laws resulting in tremendous personal liability to return funds to your investors, despite the liability shield the entity is supposed to provide. Sometimes by the time I get involved it is too late to fix this, but sometimes we can do a late filing and get some, if not all, of the protection it provides. Corporations, as well as some LLCs and partnerships, are securities and must be treated accordingly.

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I was in Los Gatos getting my hair cut this weekend and my hairdresser said something very interesting – he said that his best clients are the ones who try to do their hair themselves (especially their color) and then come to him to fix the mess they made. He said they are so grateful when he fixes the problem they created that they become clients for life. I am not the type of person to try to do my hair myself – too much risk for me. However, it struck a chord with me because it seems more and more I spend my time working with clients who have formed their own corporation or limited liability company through forms found on the internet, and then come to me to fix some problem they caused.

What is wrong with forming your own corporation or LLC online? Nothing, if you know what you are doing. However, most people who are starting a new business and need an entity do not specialize in forming companies. Here are two of the four most common (and costly) mistakes I have helped my Silicon Valley clients fix:

1. Picking the wrong type of entity — with disastrous tax consequences.

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