By: Michael L. Cox, CPA
Limited Liability Companies are becoming an increasingly popular corporate structure for companies engaged in the sale or purchase of automobile dealerships. Created by California lawmakers just a few years ago, LLC’s have steadily gained adherents as business people have come to understand the benefits of the structure. Even some existing dealerships that are not presently buying or selling are nevertheless converting into LLCs to take advantage of those benefits.
For business people establishing entities acquiring assets in dealership transactions, LLCs may be a particularly advantageous structure to consider. The purpose of this article is to detail the benefits of LLCs, which include the following:
THE BEST OF BOTH WORLDS
Do you appreciate the limited liability and asset protection of the S corporation, but don’t like the restrictions that go with it? Or perhaps you prefer the freedom and flexibility of a partnership, but don’t like having partnership assets exposed to partnership creditors? In either case, a Limited Liability Company (LLC) might be what you need.
An LLC is the best of both worlds. It offers the flexibility of a partnership and the limited liability of a corporation. An LLC can protect members’ personal assets from company creditors while protecting the company’s assets from the personal creditors of other LLC members.
MORE FLEXIBLE THAN A CORPORATION
LLCs offer several advantages over corporate business structures. While C corporations offer limited liability protection, their profits are subject to double taxation — once at the corporate level, and again at the individual level as dividends. S corporations offer limited liability, with pass-through (single) taxation. But S corporations are also subject to a number of restrictions, including the number and types of owners allowed. By contrast, LLCs offer limited liability and pass-through taxation with fewer restrictions. For example, unlike S corporations, LLCs can own stock in affiliated corporations.
LIMITED LIABILITY
Like a corporate shareholder, an LLC member’s liability is limited to the amount of his or her capital contribution. A member is not likely to be liable for another member’s personal liabilities, or liabilities arising from his or her acts relating to the LLC. But be aware that, as an LLC member, you still are liable for your own individual wrongs, such as torts, malpractice, personal guarantees, various state or federal tax liabilities, and regulatory violations.
Much like the asset protection of a limited partnership, an LLC interest is considered personal property. The only remedy available to a member’s creditor is a charging order. A charging order acts as a lien against a member’s interest. It allows the creditor to be assigned the economic benefits the member would normally enjoy, but it does not give a creditor the right to underlying LLC assets. Nor can a charging order force the sale of the member’s interest to satisfy an outstanding debt. The LLC assets remain intact.
No case law currently exists, but it appears that an LLC “veil” can be pierced in the same way a corporate veil can, and for essentially the same reasons. If this happens, members become personally liable for the LLC’s debts. To avoid this, be sure your LLC conforms to Uniform Limited Liability Company Act requirements regarding the formation and operation of an LLC. Creating an operating agreement is one of those requirements. The operating agreement is similar to the articles of incorporation for a corporation or a partnership agreement for a partnership. It is usually drafted when the LLC files in its home state for recognition as an LLC.
Treat the LLC as a separate entity, and don’t allow individual members to commingle their personal assets with the LLC’s assets. Limit your LLC’s operations and transactions to specified business purposes.
BANKRUPTCY ISSUES
Under bankruptcy laws, an LLC is treated as a partnership. Therefore, a member’s bankruptcy estate includes his or her LLC interest, but not any of the LLC’s assets.
If an LLC files for bankruptcy, it is considered a person (defined as an individual, partnership or corporation) and eligible for relief under Chapters 7 or ll. In a bankruptcy proceeding, the LLC will probably be treated as a corporation, because of its limited liability and separate entity status. In this case, state law will determine who must approve the proceedings should a voluntary petition be filed. You can avoid this by specifying in the operating agreement the voting requirements for filing a petition.
If an involuntary bankruptcy proceeding is filed, the operating agreement is recognized as an executory contract, much like a general partner’s management rights. A trustee cannot reject the executory contract because a member’s LLC interest is a personal service contract. As such, the trustee is not allowed to exercise management powers.
Many LLC statutes provide that bankruptcy of a member involuntarily dissolves the LLC entity unless the remaining members agree to continue the LLC. Otherwise, the LLC can be voluntarily dissolved at the agreement of its members at any time. Because the LLC is a relatively new form of business, these answers are not definitive.
Get the Best of Everything
An LLC has many advantages over a partnership or an S or C corporation. To determine whether an LLC is the best structure for your company, contact your qualified financial advisor, CPA or attorney.
(Michael L. Cox of Michael L. Cox & Associates is a CPA specializing in serving the automobile dealership industry. He can be reached at (909) 482-4374.)
This article was written in 1999.