Tuesday, May 16, 2006

On Limited Liability

To determine if there is in fact limited liability in a company or partnership, there are several steps you must take.

First, there's the concept of limited liability. Only God can make a tree, but only the state can make a limited liability entity. Once the necessary paperwork has been forwarded to the Secretary of State (SOS), then the SOS will ensure that all the i's are dotted and t's are crossed, and then (s)he will file the articles and create the entity (usually, the entity begins existence upon filing). After such time, any limited liability limits would naturally apply, so long as the proper requirements are met (such as indicating that liability is limited on any contractual paperwork, etc.).

But what about the time before the limited liability exists? Wherein would liability lie? That depends on many factors. The proper analysis would start with whether or not the entity was properly formed. If not, then you ask whether or not there is a General Partnership. A general partnership, generally defined, is an agreement of two or more people to carry on as co-owners a business for profit. Typically, individuals who would get together to form a limited liability entity would match your state's prerequisites for a general partnership. Then you look to the agreements that were made prior to the formation of the limited liability entity. With whom was the third party contracting? If the documents indicate that the party was contracting with a limited liability entity (e.g. the contract is signed by ABC, LLC) then, when the LLC legally comes into existence, it can assume the liability on the contract via adoption (taking affirmative steps to assume the liability on the contract). Until that time comes, the member/partner who contracted with the third party holds personal liability, as he or she, working as a promoter, or agent, of the principal, is making the binding agreement. The other members/partners in the LLC may also be liable as general partners, because in a general partnership, liability extends to all members, though they have a defense in that the third party believed they were contracting with a limited liability entity, which may shield the other members/partners. However, a person who believes he or she is entering into a Limited Partnership may avoid personal liability if, at the time he or she discovers the Limited Partnership is not in existence, he or she takes affirmative steps to remedy the deficiency or acts to remove him- or herself from an interest in the profits of the Limited Partnership.

In a situation where the third party is contracting with an individual promotor and there is no indication that the promoter is working for a Limited Liability entity (i.e. the contract says ABC, Betsey Wetzel, Member), then as an agent/promoter or as a partner, Betsey would assume liability on the contract. The other members in this situation would likely similarly be bound as the third party cannot adequately assume it is dealing with a limited liability entity. In this situation, when the Limited Liability entity does come into existence, after the deficiencies are remedied, then the limited liability entity may adopt the contract - that is to say that the entity can take liability for the contract so long as they act to do so.

Any questions?

1 comment:

Jordan said...

hi, great work, I've written a bit about Setting up LLC's myself at www.llcsetup.blogspot.com

-Jordan