Some Important Liability Considerations for Tennessee LLCs
Tennessee updated its LLC law to provide that an LLC’s limited liability shield could be “pierced” only in very limited circumstances – see the attached statute on page 4 for more specific details, particularly looking at TCA §48-249-114(e).
The above statute made it clear that the failure of a Tennessee LLC to follow formalities was not a ground for finding the underlying members of the LLC personally liable for the debts or lawsuits of the LLC (a legal theory sometimes called “piercing the veil of liability”). That is good news, but it is not the end of the story.
It is still possible for an LLC to be ineffective as a liability shield and that a court could hold the member(s) liable “under exceptional circumstances” where (1) the separateness of the LLC and its member(s) has ceased to exist because of misuse of the LLC; and (2) the misuse is so obviously bad that for the court to respect the separate existence of the LLC would lead to an injustice. Despite the statute, a court has some latitude and in Tennessee finding personal liability is rare and generally reserved only for folks who misuse the entity. Examples would be using an LLC to commit fraud or to intentionally create debt in the name of the LLC with no intention of ever paying it.
Obviously, you should never commit such fraudulent acts. However, to avoid the opportunity for an aggressive creditor or plaintiff to assert that you have misused the LLC, the following are a few guidelines to follow and to thereby show you are using the LLC properly and for its intended business purposes (and also with examples of things not to do):
- Take steps to prevent injury to others. Examples: Don’t leave an extension cord in the path of customers who could trip on it. If you have a rental property, don’t ignore complaints that the hot water heater is acting up; instead fix it before it blows up. Don’t fail to act when you know something should be done.
- Open and utilize a separate checking account for the LLC. Examples: Don’t intermingle (or “comingle”) your personal funds with the company’s accounts. Don’t use whatever checkbook is most convenient at the moment. Don’t pay your personal cable bill with an LLC check (even if you rationalize that the internet connection is important to the LLC’s office in your home). Don’t loan the LLC money all the time either. Don’t make loans to yourself from the LLC in general.
- Keep enough money in the LLC bank account to pay its upcoming bills and also an adequate reserve so the LLC can otherwise be financially responsible for its ordinary debts. Examples: Don’t zero out the account ever. Don’t pull out profits in excess of what you know will be due for bills coming up in a few weeks. Don’t deposit money personally in the LLC routinely to pay its bills, creating a pattern of the LLC not having money for its bills that you then “cover” with a transfer of personal money.
- Open a credit card in the LLC name (even if you personally guarantee it because the LLC has not established credit yet) so that purchases can be made directly in the company name. Examples: Don’t charge the online purchase of a computer or other larger item that will be used in the LLC business on your personal credit card (even though reimbursement would be acceptable in general); instead, buy it in the LLC name directly.
- Buy necessary assets to operate the business in the LLC’s name. Examples: Don’t operate the LLC with no assets of its own, even if the LLC pays rent to use your assets. Don’t forget to view the LLC as if you were an outsider and understand if some business arrangement is not believable to you, it will not be believable to others.
- Be ethical and deal with others as you would want them to treat you. Examples: Don’t engage in a course of conduct in the name of the LLC for products or services when you know that the LLC will not have funds to pay the bills. Don’t manipulate funds so the income goes to members but leaving the expenses as unpaid debts of the LLC. Don’t commit any crimes with the LLC (or personally). Don’t intentionally pay all bills except for a few select ones, unless there is a legitimate dispute over the amount due.
- Keep a distance between the members (and other businesses owned by members) and the LLC. Examples: Don’t have only one person doing everything in the business. Don’t have a single member if possible, so there will others to protect besides the principal actor. Don’t unite management of different entities, with the LLC by using another entity’s address, employees, credit rating, and management structures. Don’t do anything that looks like a “unity of identity” or “unity of operations” between the LLC and any other individual or business.
- Seek the advice of a CPA or other qualified tax professional to file a separate tax return for the LLC. Examples: Don’t file as a “disregarded entity” for federal income tax purposes, even if that is an available and legal option under federal law, unless there are pressing tax reasons where asset protection is of limited importance to you. Don’t forget that you can choose to be taxed as an S corporation even though the LLC is not a type of corporation. Don’t forget to file the Tennessee Franchise and Excise Tax Return (or an annual renewal of exemption) for the LLC. Don’t “borrow” from the government by not paying employment taxes or sales taxes, etc.
- Make estimated tax payments for the LLC if it elects to be taxed on Form 1120 OR deposit taxes personally if the LLC is taxed as a partnership or otherwise. Examples: Don’t forget that often half of the net income of a business is payable in income and self-employment taxes. Don’t forget to evaluate with your accountant what estimated taxes must be paid each quarter to avoid penalties.
- Have a signed Operating Agreement. Examples: Don’t fail to complete the process, even if state law doesn’t absolutely require you have an Operating Agreement. Don’t fail to spell out who has management responsibilities and how voting will occur. Don’t forget to follow the Operating Agreement when somebody wants to exit the LLC as a member.
- Keep minutes of meetings at least quarterly. Examples: Don’t hire an employee without having a formally documented meeting. Don’t neglect to hold an official meeting, even if no big decisions need to be made.
- Consider outsourcing some activities if you have no employees. Examples: Don’t do everything in the LLC when there is not also an employee or independent contractor who is also acting on behalf of the LLC. Don’t over-ride a management company decision, if you have one for a rental property. Don’t run the business as if you are a sole proprietor.
- Watch what title you call yourself. Examples: Don’t use the term “owner” or “shareholder” because those terms apply to sole proprietorships and corporations (and because you are instead a “member” or “manager” or “managing member” of the LLC). Don’t call yourself “President” unless the LLC is has elected to have officers.
- Have contracts that shift risk to others where possible. Examples: Don’t rent a cabin or other rental property owned by the LLC without having a good rental agreement. Don’t provide long-term services to others without a contract. Don’t forget to sign contracts using your property title (like “managing member”).
- Obtain ample liability insurance in the LLC name (or as “additional named insured”). Examples: Don’t rely on the LLC as a liability shield from lawsuits when you can get insurance at a reasonable premium. Don’t forget to ask for coverage for non-owned vehicles and other coverage that may not be in the standard general liability policy. Don’t forget that you can get an “umbrella” liability policy personally and for the LLC to cover additional risks.
- The LLC should only be considered the “last line of defense” in the event of a lawsuit. Examples: Don’t operate with reckless abandon in the thought that the LLC will protect you. Don’t forget that you can be held personally liable for your own personal actions, such as negligent supervision of employees, even if not liable for LLC debts.
In summary, do what you can to avoid someone else looking in at your LLC operations and concluding there is a “lack of separateness” and, more importantly, that the entity is not perceived as having been misused by its member(s) as a vehicle to commit some wrong. This latter element is what differentiates the real “veil piercing” case from those cases where the entity simply went bust for whatever reason, leaving jilted creditors. It is not enough that the entity failed and cannot pay its debts; the entity’s owner must have affirmatively misused the entity either for some wrongful purpose or as a wrongful means.
While the definition of what constitutes a sufficient “wrong” to support veil piercing is quite liberally interpreted, it is clear that it means something more than just that creditors are not being paid. As with everything else in modern veil piercing law, the courts measure this element by looking at the “totality of the facts and circumstances.”
If you respect the LLC, operate it as if you were an employee of someone else’s business, and you don’t try to do wrong and then stand behind the LLC as a shield to avoid the repercussions, the LLC should serve you well and provide the appropriate level of asset protection for which it was intended. However, if you don’t respect the LLC as being truly separate from yourself (and/or misuse it), you can expect that a judge and jury will not respect the LLC as a liability shield either.
Note: This summary is not intended to create an attorney – client relationship or constitute specific legal advice concerning your personal or business circumstances. This is provided for discussion purposes only. Rev. 12-2014
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As you can see, Tennessee has a strong LLC statute and it can be an important legal “tool” but requires that it be used correctly. You and the team of professionals you have chosen should periodically confirm that you are in compliance with the laws as they change.