Limited Liability Entities

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Limited Liability Entities

Sections within this essay:

Background
Entities Without Limited Liability
Corporations
Limited Partnerships
Limited Liability Partnerships
Limited Liability Limited Partnerships
Limited Liability Companies
Issues Regarding Limited Liability Entities
Taxation
"Piercing the Veil"
Liability for Torts and Other Obligations

State Laws Governing Limited Liability Entities
Additional Resources
Organizations
Council of Better Business Bureaus
Small Business Advancement National Center
United States Chamber of Commerce

Background

Since the 1990s, individuals who wish to form businesses have seen a significant increase in the types of business entities that may be formed. Laws governing these newer forms of businesses limit the liability that business owners may face. In general, a person who invests in a limited liability entity is only liable for an amount equivalent to the investment made by the investor.

Some limited liability entities resemble general partnerships, except for the limitations in liability. Other entities, especially limited liability companies, are more similar to corporations in their structure. Although some entities are taxed in a manner similar to partnerships, other forms of limited liability entities may be taxed similar to corporations.

Entities Without Limited Liability

Owners of three types of businesses are not protected by the limited liability that other business forms offer. An owner of such a business is personally liable for the debts incurred by the business. These businesses include general partnerships, joint ventures, and sole proprietorships. General partnerships are formed when two or more agree to engage in a business for profit. A joint venture is similar to a general partnership, except that two or more people form a venture for a particular business project. A sole proprietorship is a business that is carried on by an individual.

The law traditionally has not treated these types of business as independent and distinct from the owners. Owners of these types of business also do not need to follow the formalities that owners of other forms of businesses, such as corporations, must follow. Moreover, these business entities generally are not governed as heavily by state and federal regulations. Thus, although limitations on liability provide considerable incentive to form a limited liability entity, other factors may lead business owners to form an entity that does not enjoy limited liability.

Corporations

The corporation is the most common form of business entity in the United States. A corporation is formed when individuals complete certain formali-ties, including the filing of documents known as articles of incorporation and the payment of fees to the proper authority. The secretary of state in most states is the official responsible for receiving the documents and filing fees from the corporations.

Traditionally, the corporate form of business was the preferred limited liability entity because the corporation exists separate from its owners and investors. The corporation, although an artificial entity, is treated like an individual in most respects. It may enter into contracts, it may sue or be sued, and it may own property. A corporation may also exist perpetually because it may continue to exist even when owners and investors change.

As an entity separate from its owners and investors, a corporation is liable for its own contracts. Owners and investors generally are only liable to the extent of the amount that these individuals invested in the corporation.

Many states base their laws governing corporations on the Model Business Corporation Act (MBCA), which was prepared by the Section of Business Law of the American Bar Association. However, most of these states have deviated from the MBCA with respect to some of the provisions. Other states have chosen not to follow the MBCA and have instead drafted their own statutes.

Limited Partnerships

Parties form a limited partnership in a manner similar to a general partnership. The most significant difference between these two types of businesses is that some of the owners of the limited partnership, known as limited partners, do not participate in the management and control of the partnership's business. Instead, limited partners provide capital contributions to the partnership and are liable only to the extent of those capital contributions.

Like a general partnership, owners of a limited partnership enter into a partnership agreement. A limited partnership must file a certificate with an appropriate state authority, usually the secretary of state. The certificate provides the limited partnership's name and character of business, along with the names and addresses of the general and limited partners. A limited partnership's name must include "L.P.," "Ltd," or "Limited Partnership" to identify the form of the business entity. The purpose for this requirement is to warn those who deal with the partnership that some of the partners are not personally liable for the partnership's debts.

Nearly every state adopted the Uniform Limited Partnership Act, which was approved in 1916 and again in 1976 by the National Conference of Commissioners on Uniform State Laws (NCCUSL). The NCCUSL significantly revised this uniform law in 2001, though as of 2005 only a small number of states had adopted the revised version.

Limited Liability Partnerships

The limited liability partnership (LLP) emerged as a business form during the 1990s. This type of business entity is similar to a general partnership in that each partner may share in the management of the business and that each partner shares in the profits. However, unlike a general partnership, partners in an LLP do not incur personal liability for claims that are brought related to the actions of a copartner. Moreover, this form of business shields a partner from liability for the acts of the partnership's employees or agents. On the other hand, a partner in an LLP is liable for his or her own negligence or malfeasance and the negligence and malfeasance of anyone under the supervision and control of the partner.

Owners of an LLP register the business by filing a registration with the appropriate state authority, usually the secretary of state. Owners of an LLP may be required to prove that the entity has adequate liability insurance or assets to satisfy claims that may be brought against the business. This type of partnership must include the word "Registered Limited Liability Partnership" or the initials "LLP" in its name.

Every state now allows businesses to form as LLPs. The NCCUSL in 1996 amended the Uniform Partnership Act (UPA) to include sections governing limited liability partnerships. The majority of states have adopted the revised UPA.

Limited Liability Limited Partnerships

A small minority of states recognize a form of business called the limited liability limited partnership (LLLP). An LLLP is formed when a limited partnership registers as a limited liability partnership, thus allowing partners to benefit from different limitations in liability. In other words, limited partners in an LLLP are still only liable for the partnership's debts to the extent of the limited partner's contributions, while a general partner is not personally liable for the negligence or malfeasance of another general partner.

The NCCUSL modified the Uniform Limited Partnership Act in 2001 to allow limited partnerships to register as limited liability limited partnerships. Although only a small number of states had enacted the revised uniform act by 2005, several states had considered bills that would have adopted this act.

Limited Liability Companies

The limited liability company (LLC) first appeared as a business form in Wyoming during the 1970s and became more prevalent during the 1990s. This type of business entity combines aspects of a partnership with aspects of a corporation. Those who form an LLC may choose to have the owners of the company (called "members") manage the company. This type of management structure is more similar to a partnership. Alternatively, an LLC may choose to have managers run the company in a structure that is more similar to a corporation. The Internal Revenue Service allows an LLC to elect whether it wants to be taxed as a partnership or as a corporation, and so this form of business offers flexibility in both management and taxation.

In order to form an LLC, the owners must file articles of organization with an appropriate state authority, usually the secretary of state. Articles of organization are similar to articles of incorporation, which must be filed in order to form a corporation. Owners of an LLC must also pay a filing fee at the time of registration.

Members of an LLC enjoy similar protections against liability as shareholders in a corporation, limited partners in a limited partnership, or partners in a limited liability partnership or limited liability limited partnership. These members are generally not personally liable for the debts and obligations of the LLC, except in certain circumstances.

Although every state now provides for the LLC as a business entity, state laws vary from one to the next. The NCCUSL completed the Uniform Limited Liability Company Act in 1996, but only eight states and one territory has adopted this act as of 2005.

Issues Regarding Limited Liability Entities

Taxation

Corporations are taxed on one of two ways, depending on the type of corporation that has been structured. A "C Corporation," also known as a standard business corporation, is an entity that is taxed separately from its owners. Dividends that are passed on to shareholders of the corporation are also taxable, thus meaning that income received by a corporation may be taxed twice. Another type of corporation, known as an "S Corporation" is considered to be a "pass-through" entity with respect to taxation. That is, the corporation itself is not taxed, and profits and losses are passed down as income or losses to the owners of the corporation. An S Corporation is taxed in a manner similar to a partnership, which is also treated as a pass-through entity.

When new forms of business entities began to emerge in the 1990s, taxation of the entity was a major consideration. Limited partnerships and limited liability partnerships were easily classified as passthrough entities. However, the Internal Revenue Service (IRS) had some difficulty in determining how an LLC should be taxed. Under regulations that existed prior to 1997, if an LLC was operated in a manner more similar to a C Corporation, then the LLC was taxed as a corporation. However, the IRS changed its regulations in 1997 to allow an LLC to select how it should be taxed. Since the passage of those regulations, LLCs have been free to operate in a manner similar to corporations, but these LLCs may elect to be taxed like partnerships.

"Piercing the Veil"

Under the law governing corporations, where an owner or owners of a corporation use the corporate form of business to engage in fraud while hiding behind the shield of limited liability, a court may hold the owners of the corporation personally liable to a third party. This is referred to as piercing the corporate veil. Since partners in a general partnership are personally liable for the debts of the partnership, this theory of liability did not apply to entities other than corporations.

Because these new limited liability entities shield owners of businesses from personal liability, commentators have suggested that the piercing-the-veil theory can apply to LLCs and LLPs. This theory would apply only in narrow circumstances, such as where owners of an LLC or LLP fail to follow proper formalities in forming or running the business, or where the business entity is being used to perpetuate fraud.

Liability for Torts and Other Obligations

Owners and managers of limited liability entities are never completely shielded from personal liability. For instance, laws that govern these types of entities do not generally shield owners or managers from liability for torts that are committed while the person is acting on behalf of the business. Whether a business owner or manager is shielded from liability with respect to his or her involvement in the business depends on the type of limited liability entity and the individual state law that governs that type of entity.

State Laws Governing Limited Liability Entities

ALABAMA: The state has adopted provisions of the Model Business Corporation Act. The state adopted the 1997 version of the Uniform Partnership Act, including provisions governing limited liability partnerships. The state also adopted the Uniform Limited Liability Company Act.

ALASKA: The state adopted the 1997 version of the Uniform Partnership Act, including provisions governing limited liability partnerships.

ARIZONA: The state has adopted provisions of the Model Business Corporation Act. The state adopted the 1997 version of the Uniform Partnership Act, including provisions governing limited liability partnerships.

ARKANSAS: The state has adopted provisions of the Model Business Corporation Act. The state adopted the 1997 version of the Uniform Partnership Act, including provisions governing limited liability partnerships.

CALIFORNIA: The state adopted the 1997 version of the Uniform Partnership Act, including provisions governing limited liability partnerships.

COLORADO: The state has adopted provisions of the Model Business Corporation Act. The state adopted the 1997 version of the Uniform Partnership Act, including provisions governing limited liability partnerships.

CONNECTICUT: The state adopted the 1994 version of the Uniform Partnership Act.

DELAWARE: The state adopted the 1997 version of the Uniform Partnership Act, including provisions governing limited liability partnerships.

DISTRICT OF COLUMBIA: The state has adopted provisions of the Model Business Corporation Act. The state adopted the 1997 version of the Uniform Partnership Act, including provisions governing limited liability partnerships.

FLORIDA: The state has adopted provisions of the Model Business Corporation Act. The state adopted the 1997 version of the Uniform Partnership Act, including provisions governing limited liability partnerships. The state also adopted the 2001 revisions to the Uniform Limited Partnership Act.

GEORGIA: The state has adopted provisions of the Model Business Corporation Act.

HAWAII: The state has adopted provisions of the Model Business Corporation Act. The state adopted the 1997 version of the Uniform Partnership Act, including provisions governing limited liability partnerships. The state also adopted the Uniform Limited Liability Company Act and the 2001 revision to the Uniform Limited Partnership Act.

IDAHO: The state has adopted provisions of the Model Business Corporation Act. The state adopted the 1997 version of the Uniform Partnership Act, including provisions governing limited liability partnerships.

ILLINOIS: The state adopted the 1997 version of the Uniform Partnership Act, including provisions governing limited liability partnerships. The state also adopted the Uniform Limited Liability Company Act and the 2001 revision to the Uniform Limited Partnership Act.

INDIANA: The state has adopted provisions of the Model Business Corporation Act.

IOWA: The state adopted the 1997 version of the Uniform Partnership Act, including provisions governing limited liability partnerships. The state also adopted the 2001 revisions to the Uniform Limited Partnership Act.

KANSAS: The state adopted the 1997 version of the Uniform Partnership Act, including provisions governing limited liability partnerships.

KENTUCKY: The state has adopted provisions of the Model Business Corporation Act.

MAINE: The state has adopted provisions of the Model Business Corporation Act.

MARYLAND: The state has adopted provisions of the Model Business Corporation Act. The state adopted the 1997 version of the Uniform Partnership Act, including provisions governing limited liability partnerships.

MASSACHUSETTS: The state has adopted provisions of the Model Business Corporation Act.

MINNESOTA: The state adopted the 1997 version of the Uniform Partnership Act, including provisions governing limited liability partnerships. The state also adopted the 2001 revisions to the Uniform Limited Partnership Act.

MISSISSIPPI: The state has adopted provisions of the Model Business Corporation Act. The state adopted the 1997 version of the Uniform Partnership Act, including provisions governing limited liability partnerships.

MISSOURI: The state has adopted provisions of the Model Business Corporation Act.

MONTANA: The state has adopted provisions of the Model Business Corporation Act. The state adopted the 1997 version of the Uniform Partnership Act, including provisions governing limited liability partnerships. The state also adopted the Uniform Limited Liability Company Act.

NEBRASKA: The state has adopted provisions of the Model Business Corporation Act. The state adopted the 1997 version of the Uniform Partnership Act, including provisions governing limited liability partnerships.

NEVADA: The state adopted the 1997 version of the Uniform Partnership Act, including provisions governing limited liability partnerships.

NEW HAMPSHIRE: The state has adopted provisions of the Model Business Corporation Act.

NEW JERSEY: The state adopted the 1997 version of the Uniform Partnership Act, including provisions governing limited liability partnerships.

NEW MEXICO: The state has adopted provisions of the Model Business Corporation Act. The state adopted the 1997 version of the Uniform Partnership Act, including provisions governing limited liability partnerships.

NORTH CAROLINA: The state has adopted provisions of the Model Business Corporation Act.

NORTH DAKOTA: The state has adopted provisions of the Model Business Corporation Act. The state adopted the 1997 version of the Uniform Partnership Act, including provisions governing limited liability partnerships. The state also adopted the 2001 revisions to the Uniform Limited Partnership Act.

OKLAHOMA: The state adopted the 1997 version of the Uniform Partnership Act, including provisions governing limited liability partnerships.

OREGON: The state has adopted provisions of the Model Business Corporation Act. The state adopted the 1997 version of the Uniform Partnership Act, including provisions governing limited liability partnerships.

RHODE ISLAND: The state has adopted provisions of the Model Business Corporation Act.

SOUTH CAROLINA: The state has adopted provisions of the Model Business Corporation Act. The state also adopted the Uniform Limited Liability Company Act.

SOUTH DAKOTA: The state has adopted provisions of the Model Business Corporation Act. Provisions of the state's partnership statute are similar to 1997 version of the Uniform Partnership Act, including provisions governing limited liability partnerships. The state also adopted the Uniform Limited Liability Company Act.

TENNESSEE: The state adopted the 1997 version of the Uniform Partnership Act, including provisions governing limited liability partnerships.

TEXAS: The state has adopted provisions of the Model Business Corporation Act. The state adopted the 1997 version of the Uniform Partnership Act, including provisions governing limited liability partnerships.

UTAH: The state has adopted provisions of the Model Business Corporation Act.

VERMONT: The state adopted the 1997 version of the Uniform Partnership Act, including provisions governing limited liability partnerships. The state also adopted the Uniform Limited Liability Company Act.

VIRGINIA: The state has adopted provisions of the Model Business Corporation Act. The state adopted the 1997 version of the Uniform Partnership Act, including provisions governing limited liability partnerships.

WASHINGTON: The state has adopted provisions of the Model Business Corporation Act. The state adopted the 1997 version of the Uniform Partnership Act, including provisions governing limited liability partnerships.

WEST VIRGINIA: The state adopted the 1994 version of the Uniform Partnership Act. The state also adopted the Uniform Limited Liability Company Act.

WISCONSIN: The state has adopted provisions of the Model Business Corporation Act.

WYOMING: The state has adopted provisions of the Model Business Corporation Act. The state adopted the 1994 version of the Uniform Partnership Act.