If you’re starting a company, you may wonder whether a Limited Liability Company (LLC) or a corporation is the better entity type to meet your needs. LLCs and corporations are both legal entities that allow business assets and the personal assets of the owners to be separate from the LLC’s debts and liabilities. While both structures offer protection from liability, there are many differences between the structures.
What is Limited Liability?
Limited liability is a type of legal protection that prevents an individual from being personally responsible for a company’s debts and obligations. Limited liability insulates an owner from being accountable for the losses incurred by the business. This protection also prevents the owner’s personal assets from being subject to bankruptcy or other legal matters involving the business.
Limited Liability in LLCs
A limited liability company (LLC) should not be confused with a corporation. An LLC is a hybrid entity that combines the features of a corporation and a sole proprietorship. It has the limited liability of a corporation and the flexibility of a sole proprietorship or partnership. Many business owners choose the LLC structure for the benefits that come with pass-through taxation. Any profits, losses, and operating costs of the company can be deducted from the personal tax returns of a member, which can be helpful in offsetting other income.
In many jurisdictions, the law limits what an LLC member’s creditor can obtain from the member and the limited liability company with a “charging order.” A charging order requires the LLC to pay any member distributions that are due to the creditor instead. In these states, the creditor of a member cannot become a member with management rights or otherwise touch the member’s ownership of the LLC.
While New York allows for charging orders, New York does not limit charging orders to be the only remedy for an LLC member’s personal creditors. A creditor can also foreclose on a member’s interest and a court can order that the member’s financial rights in the LLC be sold to the creditor. In such cases, the creditor would become the owner of the member’s financial rights — including the right to receive distributions from the LLC or a share of the assets in the event of dissolution. A creditor may also seek judicial dissolution and a court order to sell the LLC’s assets to satisfy the creditor’s judgment.
How is Liability Limited in a Corporation?
Like LLCs, a shareholder’s liability for business debts is limited in a corporation. If a judgment is issued against the corporation, owners cannot be forced to use their personal assets or property to pay the company’s debts.
Even though a shareholder’s assets might have protection from creditors of the company, the company may face a potential risk from the creditors of a shareholder. For example, in a shareholder’s judgment creditors can attach the shareholder’s stock and assume their voting rights. If a shareholder has a controlling interest in the company, the creditors might vote to dissolve it.
Piercing the Corporate Veil
There are certain circumstances in which personal liability might attach in an LLC or corporation. If a court determines that an owner has abused their control, engaged in fraud, used the business entity to commit a crime, or committed some other wrongdoing, it may determine that the corporate veil can be pierced. Limited liability would be put aside and a corporation’s shareholders or directors — or an LLC’s members — could be held personally liable for the actions of the corporation or debts incurred.
Contact a Skillful New York Business Law Attorney
If you’re starting a business, it is essential to have the guidance of an experienced business law attorney who can help ensure you structure your company in a way that offers protection from personal liability. Brinen & Associates provides skillful advice to entrepreneurs and business owners for issues concerning entity formation and a wide variety of business matters. Call (212) 330-8151 or send us a message to learn more about how we can help.