The single member LLC is touted as one of the best business entity choices for sole proprietors seeking protection from lawsuits and business debt. These entities are, in fact, very good for just this purpose. They do carry, however, a high level of risk for the unwary own. How so? It is easy to fall into bad habits that can end up terminating the protection provided by the limited liability company.
Let's start with the basics. What is a single member LLC? An LLC does not have shareholders that own it as is typical with corporations. Instead, the entity is owned by “members”. The Single member LLC is thus a limited liability company owned by only one person. This, unfortunately, can lead to a host of problems if the owner gets lazy.
The liability protection provided by the limited liability company is based on a legal fiction. This fiction states that the entity, for legal purposes, is the equivalent of a human being under the law. This means that it can enter into contracts, commit negligent acts, drink too much…err, not that last one. Regardless, this fiction creates some duties and obligations upon the member.
As a general rule, the member must treat the LLC as though it is a separate business entity. If the member starts commingling their personal finances with the LLC, then a creditor could argue that the entity is a sham and should be set aside with the member becoming personally liable for the debt in question. This is known as piercing the corporate veil, although technically it would be called piercing the LLC veil in this instance.
The LLC is often touted as being a great business choice because it does not require a person to follow corporate formalities. While legally correct, a single member LLC should follow them in detail. Why? There is such an opportunity for the company to be considered the default play thing of the member that it is critical that an effort be made to show that the opposite is true. Keeping annual minutes and what have you is the way to do this.
The single member LLC definitely has its place in the modern business environment. That being said, make sure you make the necessary effort to establish that it is being run like a formal business or you will risk having the protection it provides penetrated and your personal assets exposed.
Richard A. Chapo is with SanDiegoBusinessLawFirm.com – providing warnings about the single member LLC time bomb most member owners are unaware they are facing.