The LLC: Everything You Ever Wanted in a Partnership – and Less

The limited liability company (LLC) is similar to a partnership in that its members enjoy pass-through tax treatment whereby only the individual members are taxed. That is, the entity itself is not subject to tax. Thus, the LLC, like a partnership, avoids the so-called “double tax” that is imposed on corporations. However, unlike partners in a general partnership, the LLC can insulate its members from personal liability for company debts and other obligations. In an LLC, the liability of each member is generally limited to the amount of the individual member’s contributions to the company.

Under Oregon law, a partnership is liable for loss or injury caused to a person as a result of a wrongful act or omission, or other actionable conduct, of a partner acting in the ordinary course of business of the partnership (or with the authority of the partnership). This treatment renders each partner jointly and severally liable for all partnership obligations, including liability for negligent acts and contractual obligations.

A liability is said to be “joint and several” when the creditor or injured party may demand payment from (or sue) one or more of the partners, or all of them together, at the creditor’s option. Instead of being liable for only his or her “share” of the debt, each partner may be held personally liable for the entire obligation. This means that a general partner is risking his or her personal assets to pay claims made against the partnership.

The use of an LLC effectively eliminates partnership “joint and several liability.” Again, the extent of an LLC member’s liability is generally limited to the particular member’s capital contribution to the LLC. So while members continue to risk their individual contributions to the LLC, their personal assets are protected.

The members of an LLC should be mindful that the insulation from liability is only granted to the LLC members with respect to LLC debts and obligations and does not extend to “individual or personal” obligations of an individual. That is, members of an LLC remain liable for their own negligent or intentional acts. Furthermore, individual guarantees mean exactly what they say, the guarantor is individually liable for the debt or obligation even if the guarantee is made in conjunction with a company transaction.

Those with existing partnerships should consider converting to an LLC. The conversion of a partnership to an LLC requires the transfer of partnership assets and liabilities to a newly formed LLC. In almost all instances, the conversion of a partnership to an LLC will be a tax-free event.

The conversion requires the formation of an LLC, which is done by filing “Articles of Organization” with the Oregon Secretary of State’s office. Once the articles are filed, each partner must assign his or her individual partnership interest to the newly formed LLC, after which, each LLC member must enter into what is formally called an “Operating Agreement.” The Operating Agreement takes the place of the old partnership agreement, if one existed.

Considering that limited liability is a primary reason for choosing to create, or convert to, an LLC, the members should be careful to guard and maintain their limited liability. Just as with a corporation, the privilege of limited liability carries with it the obligation to conduct business as a company, and abuse of the privilege may create personal liability in the members for the debts or obligations of the LLC.

Even if you have already converted to an LLC, the following important safety tips can help insure insulation from personal liability:

Operate the company only under registered names;
Make sure third parties dealing with the entity are aware that it’s an LLC;
If possible, avoid personal guarantees;
Keep financial transactions involving the LLC separate from personal financial matters;
Maintain appropriate insurance for company property;
Maintain arm’s-length leases of LLC property;
Keep appropriate company records and utilize proper accounting procedures; and
File appropriate tax returns.

If you have questions about the issues raised in this article, please contact us.