As vehicles for doing business, Limited Liability Companies ("LLC's") are all the rage. And with good reason. They carry the benefits of limited liability — like corporations — without being double-taxed like corporations. Effective October 23, 1999, the Oregon legislature amended ORS Chapter 63, to make LLC's even more appealing.
One of the things the new law does is to make it clear that members of an LLC do not become personally liable for the debts, obligations, or liabilities of an LLC simply because they failed to observe traditional corporate-type formalities. In this regard, ORS 63.165(2) specifically provides:
The failure of a limited liability company to observe the usual limited liability company formalities or requirements related to the exercise of its limited liability company powers or management of its business is not a ground for imposing personal liability on the members or managers for liabilities of the limited liability company.
This and other amendments to the Act bring Oregon into line with other states that follow the Uniform Limited Liability Company Act. As amended, the statute potentially makes an LLC a better shield from personal liability than a corporation because corporations must still comply with the formalities.
"Piercing the corporate veil" is the equitable remedy courts use to disregard the corporate or LLC structure and hold members or shareholders personally liable for the company's obligations. Historically, in order to pierce the veil of a corporation or LLC, a court must find:
- A member exercises control over the entity (this could be a corporation with a controlling shareholder, a single member LLC, or an LLC whose owners are husband and wife);
- The member in control engages in improper conduct in the exercise of control over the entity; and
- This improper conduct caused a plaintiff to have the inability to obtain an adequate remedy from the LLC.
In the past, courts have looked at numerous factors to determine whether a controlling member/shareholder engaged in improper conduct. A failure to maintain records and abide by other traditional corporate formalities designed to protect the rights and define responsibilities of owners, officers, creditors and others could lead a court to disregard the entity and hold the controlling member personally liable. Other activities that could lead to piercing the veil include:
- Commingling LLC funds with personal funds
- Diverting LLC funds or assets to non-LLC uses
- Using the entity as a mere shell
- Failing to properly capitalize the entity.
What the new amendment does is take the issue of failure to keep proper records and comply with LLC formalities out of the equation. In other words, in determining whether to disregard the LLC structure and hold a member personally liable, the court can no longer consider whether a controlling member failed to hold meetings or keep adequate records.
This change in the law should not affect how anyone runs an LLC, however. The astute businessperson knows there are a myriad of other reasons to maintain good records.
- Business relationships. When businesses enter joint ventures or extended business relationships, the agreements they sign typically require warranties that the entity is authorized to engage in the relationship. These representations are important because, if the person signing the document does not have authorization to enter the agreement, the entity may later deny the agreement's validity.
- Lenders and banking relationships. Banks require evidence that a business is duly organized and indications that particular individuals have authority to sign company checks. Similarly, lenders like to make sure they are loaning money to an entity that has the legal right to incur debt. This is the case even when lenders require personal guarantees.
- Fiduciary duties. One of the biggest threats a majority owner of an LLC faces is a claim of breach of fiduciary duties owed to minority members. Good record keeping reduces the likelihood of success on such claims. When all actions requiring approval of a certain number of members are properly memorialized, there can be little question as to the compliance of the majority members with their fiduciary obligations. Keeping good records leaves a paper trail that protects not only the majority members, but the minority members as well.
What kind of records should be kept?
The members and managers of an LLC are required by law to keep some records — and to make them available for inspection by the members of the LLC. Those records include:
- List of members, past and present
- Articles of organization
- Tax returns for the past three years
- Current operating agreement with all amendments, if a written agreement exists
Other records that should be kept include:
- Bank statements
- Meeting minutes
- Resolutions authorizing activities that, either by law or under the terms of the operating agreement, require a vote of the members.
While the recent change to the LLC statute allows a business owner to focus more on business and less on keeping the LLC's records in good order, the astute businessperson will recognize that the time spent keeping good records will avoid costly problems in the future. Keeping good records, moreover, helps the owner grow the business by aiding the process of obtaining financing, developing long-lasting relationships with other businesses, and reducing intra-entity conflict.
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