10 Ways to Keep Your Liability Protection Intact

By Jennifer Reuting

Now, really, what is the point of a limited liability company without the limited liability part? Without limited liability, it’s no better than an expensive sole proprietorship — no special protections, no special tax treatment, no ability to issue shares of ownership.

If you don’t take the simple steps necessary to keep your limited liability intact, you may as well save yourself the filing fee for creating your LLC and be prepared to kiss your hard-earned personal assets goodbye if you’re sued.

File the LLC properly

The first step to obtaining liability protection is filing the LLC. Often, entrepreneurs get too busy and distracted; after all they’re running a business! They start their LLC paperwork and then leave it to sit on their desk, collecting dust, until they find the time to get around to filing it.

Find a partner

Because LLCs were initially created as partnerships, some states don’t even allow you to form an LLC with only one member (called a single-member LLC). Even if your state does allow the formation of a single-member LLC, don’t blur the line between what is allowed and what is advised.

You may be able to form and operate a single-member LLC without a problem; however, when a business lawsuit comes up, depending on the state, the court may treat you differently than it would a standard, multimember LLC. Namely, it may not give you the benefit of charging order protection.

Charging order protection is a form of liability protection unique to LLCs that keeps your business safe in the event you get sued personally. If you’re like most entrepreneurs, your business is your biggest personal asset, so this shield may be more important to you than the standard form of liability protection!

Create an operating agreement

Your operating agreement is the backbone of your company. It creates the infrastructure and acts as an operations manual that you and your partners will fall back on time and time again to sort out the gray areas and disputes that occur during the normal course of business.

Until your operating agreement has been created, your LLC isn’t complete. Creating a comprehensive, foolproof operating agreement for your LLC should be at the top of your to-do list. LLCs are very flexible entities, and in your operating agreement you can tailor your LLC to whatever your needs are.

State law gives LLCs an incredible amount of leeway for how they want to be structured and operated, but without an operating agreement in place that includes all specifications, your LLC must abide by the state’s default laws. These laws are often strict, unfavorable, and offer very little liability protection. That’s why you must create an operating agreement for your LLC before engaging in any sort of business.

Capitalize the company

The phrase capitalizing the company means investing money into your business. A business without even a little bit of money isn’t really a business at all. Usually you need to invest some capital to get your business going.

The easiest way for a court to determine whether your company is a separate operating business or an alter ego (a company put into place to protect its owners) is to see whether you’ve invested in the business.

File your annual reports

You must file your annual reports on time each year. If you fail to file your reports, you’ll go out of good standing with the secretary of state. If you remain out of good standing for a certain amount of time (usually a year), then your LLC will automatically be revoked, and you’ll have no limited liability protection at all. Not good!

Hold member meetings regularly

Although annual meetings are only required for corporations and not LLCs, you must hold them anyway. If a creditor of your LLC wants to attach your personal assets to a lawsuit, he will attempt to prove one of two things:

  • Your LLC is an alter ego.

  • Your LLC appears to be a sole proprietorship or general partnership and should be treated as one.

The best defense against these attacks is to choose to go through the same formalities that corporations are required to go through.

Obtain your licenses and permits

Before opening your doors and taking orders from customers, you need to make sure that you’re squared away in the eyes of the law. Many state governments require businesses to have licenses and permits in an effort to control various industries and obtain tax revenue. Most companies only need to file a state and city (or county) business license.

However, if you’re in a heavily regulated industry, such as gambling, alcohol, or land development, you need to inquire as to which licenses and permits you must obtain.

Avoid commingling funds and assets

Commingling, treating your business’s funds and assets as your own, is the biggest way, by far, to kill your LLC’s liability protection. Here are a few examples of commingling:

  • You use the funds from your business for obvious personal expenses without documentation.

  • Your personal bank account and your business bank account are the same.

  • You endorse checks to yourself that are made payable to your business.

  • You often move money between your business and personal accounts without keeping proper records.

Sign your documents correctly

In the course of business, you’ll have to sign stuff. Lots of stuff. When you’re doing business under your company name, you must sign as a representative of the company. What this rule means is that under your signature, you must include your title and the company name, or you must write “on behalf of” and your company name. Also, always use “LLC” or “Limited Liability Company” after your company name.

Give up some control

To avoid having the courts determine that your company is an alter ego, you need to limit your control somewhat. If you have 100 percent control over all the company’s decisions and finances, and your company does something wrong, the courts could easily hold you personally liable. This scenario is one of the most common ways to lose your liability.