From The KDDK Advantage - January 2007

The Limited Liability Shield:
An Appellate Court Decision
By Alan Shovers

At long last, the first Indiana test case. We now have a definitive answer regarding limited liability for Limited Liability Companies (LLCs). They are now the favored way of organizing businesses, replacing corporations as the vehicle of choice. As the name indicates, LLCs provide limited liability to entity owners and managers, but tax-wise, they are treated like partnerships. The best of both worlds. However, lawyers have been waiting to see how this limited liability shield will be interpreted by the courts.

The answer can be seen in a recent Indiana Appellate Court decision on Troutwine Estates Development, Co., LLC. In this case of “first impression,” an engineering firm, ComSub Design — who provided $72,000 of professional design services— tried to break through the shield of Troutwine’s LLC entity and assess the liability to the managers and owners of Troutwine. Troutwine had refused to pay ComSub the $72,000, claiming professional negligence.

The Indiana Appellate Court said “no” to ComSub in regard to the individual liability, stating that it would treat this personal liability issue by the same standards that it treats corporations.

So now, whether the law is dealing with a corporation or an LLC, the standard for allowing either entity to break through the protective liability veil is virtually identical. A multifaceted test will be used to determine whether business owners, officers and directors have adhered to corporate formalities, and the results of this test will determine whether they can be lawfully protected from an entity’s liabilities. Some of the factors that will be weighed in this test are:

1. Undercapitalization
2. Absence of corporate records
3. Fraudulent representation
4. Use of the entity to promote fraud, injustice or illegal activities
5. Payment of personal obligations
6. The blending together of personal business and corporate business
7. Other conduct that ignored, controlled or manipulated the entity’s business structure

To help prevent exemption from personal liability protection under an LLC or corporate organization, owners, officers and directors should hold regular meetings, elect managers, keep a minute book that records all meetings and avoid mixing personal business with other business.

If you have a question or would like more information about LLCs, contact Alan Shovers at ashovers@kddk.com or call him at 812-423-3183. Alan practices in the areas of business planning & transactions, federal income, estate & gift taxation, labor & employment, education, health care and real estate.

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