I had a client come in recently that had a small construction company that he had set up as an LLC. That part was fine, and a lot of people use an LLC as a business structure. This client thought that as long as there was an LLC, all of his personal assets were protected in case there was any legal action against the company. He had started the company with $100.00 and he had been told that his personal liability would be limited to the amount of his initial investment.
The problem is that even though he had set up the LLC, he did not really treat the LLC as a separate legal entity. He used the company checking account to pay all of his personal expenses. Since the income from the LLC flowed through his personal income tax return, that made sense to him. After all, it was really his money. So when the house payments were made using checks from the company checking account, it never dawned on him that the house might be considered as belonging to the company and might be attached if someone got a judgement against the company.
He had used an online service to create the LLC and he had filed the ‘Articles of Organization’ just as required. He had also paid the fees to the service to get the name of his LLC approved and to get a new tax ID for his company (as an aside, you really don’t need to pay for these services). When he went to the bank to open his checking account, the bank required that he have a business license for the area, so he did that too. He was all set. And since the company was his only source of income, he thought it would be easier to just use the one account for all of his banking needs. That way, he didn’t need to pay any service fees for a different checking account.
He didn’t create an ‘Operating Agreement’ because it wasn’t required by the state and nobody at the internet site told him it might be a good idea. He didn’t keep track of any changes to how he was managing the company or how he spent the money, because nobody told him he should.
Let’s suppose that one of his customers didn’t like something he had done and the customer sued the company. The owner thinks his house and cars are safe because they were titled in his personal name and the customer had sued the company. The customer will probably argue that the house and vehicles really belonged to the company because all of the payments had been made by the company directly from the company checking account. What would happen?
As with most legal situations, the answer is ‘it depends’. The one thing that we can be sure of is that there will be legal fees to try to sort it all out.
It would be much easier to separate the business assets from the client’s personal assets if the client had created an ‘Operating Agreement’ and established a set amount each month to be paid to himself as a salary which was then put into a separate checking account out of which he paid his personal expenses. The ‘Operating Agreement’ can also make provisions for the payment of a bonus if there is a month where the income is more than usual. The ‘Operating Agreement’ might also make provisions for the company use of a personal asset like a truck.
In fact, the ‘Operating Agreement’ can outline a lot of different things that can happen with a company and tells everyone how the company will be managed and operated. As long as you act according to the terms of the ‘Operating Agreement’, it is much easier to establish whether something is an asset of the company or a personal asset.
I know it seems cheaper to set up your company using an internet service instead of going to an attorney, but you should consider the possibility of future costs as well as the costs today. Even if all you do is get an initial consultation, what you learn in that consultation might save you a lot more in the long run.
If you have any questions about this or any other legal subject, please feel free to give us a call at 757-234-4650 or visit our website at http://www.BeaversLaw.com.
