You chose to operate as a limited liability company (LLC) to keep the company owners from exposure to the business’s liabilities in the event of financial or legal problems. But how do you make sure your company keeps its LLC status?
Maintaining your limited liability status goes beyond complying with the State of Ohio’s procedural formalities. Owners must also keep themselves separate from the company to avoid what’s known as “piercing the veil,” a process that essentially negates the limited liability aspect of the LLC.
Some business owners have recently discovered, having an LLC does not always protect the owners from personal liability. Indeed, an Ohio appellate court upheld a trial court’s decision to pierce the corporate veil and hold individual owners liable for damages and attorney’s fees awarded in a breach of contract suit. (Denny v. Breawick, L.L.C., 2019-Ohio-2066.)
To keep your LLC protected from similar issues, make sure you are up to date with any filings the Secretary of State requires. Just as importantly, make sure that you have created a sufficient distance between the owners and the LLC to avoid veil piercing.
Keep up with the formalities
In January 2021, Ohio enacted the Revised Limited Liability Company Act (“Revised LLC Act,” Ohio Rev. Code §§ 1706.01-1706.84), which completely superseded the prior Limited Liability Company Act (Ohio Rev Code §§ 1705.01-1705.61).
The Revised LLC Act is in effect as of April 2021, but the old Act remains in effect and will be phased out (repealed) in April 2022. This implementation period gives business owners a year to comply.
LLCs must continuously maintain a statutory agent.
All Ohio limited liability companies must continuously maintain a statutory agent for service of process, and the revision to the law has not changed that. Previously entitled “Statutory Agents,” the section is now “Maintenance of agent for service of process in the state.”
The Revised Act contains two key changes regarding maintaining a statutory agent:
- First, it makes clear that both domestic and foreign LLCs, i.e., LLCs organized outside of Ohio but registered to conduct business in Ohio, must maintain statutory agents. The prior act contained no specific language about whether foreign LLCs had to comply.
- Second, and most importantly, the Revised Act adds a provision explicitly stating that failure to maintain a statutory agent continuously and adequately may result in the cessation of the LLC.
LLCs must also keep current contact information for their statutory agent of file with the Secretary of State. So, if your statutory agent moves, your LLC must promptly file updated contact information. You must also notify the Secretary of State of any changes in your statutory agent.
LLCs must also ensure that their statutory agent remains qualified to act in that capacity. Statutory agents can be any individual Ohio resident or company with a business address in Ohio. But if, for example, your statutory agent moves out of Ohio, they can no longer act on your behalf. You must then promptly appoint a new agent and notify the Secretary of State accordingly.
What happens if an LLC fails to update information about its statutory agent promptly? Suppose the Office of the Secretary of State becomes aware that an LLC no longer has a valid statutory agent. In that case, it will send the LLC notice and allow them to resolve the issue. Suppose the LLC does not file information about a new statutory agent within 30 days of the notice’s mailing date (or by another time prescribed by the Secretary). In that case, the LLC ceases to exist without any additional action by the Secretary. LLCs can seek reinstatement following a cancellation.
Links to the form for updating information about your statutory agent and an online portal for filing are available here.
LLCs do not need to file annual reports.
Ohio does not require registered LLCs to file annual reports. Limited liability partnerships (LLP), on the other hand, do have to file reports every other year. Fortunately, the form is quite simple, requiring only basic information about the members of the LLP and contact information for the company headquarters, as well as an Ohio corporate address if the LLP’s headquarters are not in-state. The biennial report form and online filing access are available here.
Keep liability with the company instead of the owners
LLC owners must take steps to keep a distance between themselves and their LLC to ensure they do not become liable for company debts or actions.
Ohio courts use what’s known as the Belvedere test to determine whether to pierce the corporate veil and impute liability to the owners of an LLC. The Belvedere test requires the court to address three questions:
(1) Was the LLC just an alter ego for the owners? That is, was control over the corporation “so complete that the corporation has no separate mind, will, or existence of its own”?
(2) Was control over the corporation “exercised in such a manner as to commit fraud or an illegal act” against the person asking the court to pierce the veil?
(3) Did the plaintiff suffer injury or unjust loss from the exercise of control and the alleged wrong?
How do you know if your LLC is merely an alter ego? The courts consider several factors indicative of alter ego status, most of which deal with observance of corporate formalities and whether the owners fail to treat corporate funds separately from their own. If you’re unsure about your LLC’s status, consider the following questions:
(1) Do you hold annual corporate meetings in compliance with your operating agreement or bylaws? Unfortunately, many smaller LLCs (those with few owners) do not observe this corporate formality, putting themselves at risk of veil piercing.
(2) Do you properly maintain corporate records? If not, the likelihood of veil piercing increases.
(3) Do you keep LLC money in separate bank accounts, the owners’ accounts, and avoid intermixing or commingling the two? Again, failure to ensure separation suggests that the LLC is nothing more than an alter ego. Concerning loans between the LLC and its owners, the best practice is to document such loans with promissory notes.
(4) Do you ever use LLC property for personal purposes? If so, your LLC may be your alter ego.
If you have questions about whether your LLC is doing everything necessary to maintain your limited liability status, seek advice from your business attorneys. A few simple actions can save you many future headaches and, potentially, money.
Shareholder derivative suits
Further testing the principles of limited liability are shareholder derivative suits, where a member or shareholder of a corporation brings suit for wrongs done to the business when the business refuses to pursue those claims itself. Shareholder derivative suits are more commonly associated with corporations, but LLC members can also file them.
In closely held companies, derivative suits typically involve an owner suing on behalf of the company for misconduct by another owner or an officer or director of the business. Examples of this can be a breach of fiduciary duties or wasting company assets. Under Ohio law, in a derivative suit, the plaintiff must fairly and adequately represent the interests of similarly situated shareholders; otherwise, the court must dismiss the case.
It can be challenging to determine when an owner should pursue direct individual action instead of a shareholder derivative suit. Consider the actual injury to the company. Did only a single owner suffer any court-recognizable damages, or did the shareholders as a class? If you are considering a derivative suit, you should discuss your options with your attorneys.
Before bringing a shareholder derivative suit, the plaintiff must attempt to resolve the issue with the company’s board. The complaint in the derivative suit must also detail those efforts with all the particulars.
Shareholder derivative suits can have significant consequences. As just one recent example, Ohio-based FirstEnergy Corp. is currently defending a series of shareholder derivative suits related to the company’s alleged attempted bribery efforts to garner bailout funds.
Business insurance for LLCs
Even though your LLC limits the liability exposure of company owners, you should invest in business insurance to have the best overall protection for the business and the owners. Ohio only requires that most businesses carry workers’ compensation and commercial automobile insurance to the extent necessary. For certain occupations and professional corporations, errors and omissions liability insurance are necessary.
However, there are several other types of policies your LLC should consider:
- General commercial liability insurance covers harm to a third party that occurs during interactions with your business (e.g., bodily injury, property damage, etc.).
- Commercial property insurance covers damage to your facilities and equipment.
- Errors & omissions (E&O) insurance, also known as professional liability insurance, covers financial harm resulting from professional work performance (think malpractice insurance).
- Director & officer (D&O) insurance covers company executives for claims arising from the regular performance of their duties. Issues implicating D&O insurance coverage may very well also be the basis for a shareholder derivative suit.
- Key person insurance protects the company if a critical employee dies (for example, a founder and primary product developer).
- Cybersecurity insurance is increasingly important today as cyberattacks become more frequent. This insurance helps mitigate losses arising from data breaches and other cyber incidents and minimize business interruptions resulting from attacks.
The COVID pandemic caused substantial losses as businesses shut down across the globe. Many companies without sufficient business insurance failed. Review your policies and ensure that you have business interruption/business continuity protection so that you are well-protected in the event of another pandemic or similar disaster.
This article is for informational purposes only. It is merely intended to provide a very general overview of a certain area of the law. Nothing in this article is intended to create an attorney-client relationship or provide legal advice. You should not rely on anything in this article without first consulting with an attorney licensed to practice in your jurisdiction. If you have specific questions about your matter, please contact an attorney licensed to practice in your jurisdiction.
Gertsburg Licata is a full-service, strategic growth advisory firm focused on business transactions and litigation, M&A, and executive talent solutions for start-up and middle-market enterprises. It is also the home of CoverMySix®, a unique anti-litigation audit developed specifically for growing and middle-market companies.