How a limited liability company affects creditors.(REQUIRED READING)

Even though the Limited Liability Company (LLC) has been in existence for over a decade, it is still a mysterious entity for many creditors. Most people do not understand what rights an LLC gives its members, or what challenges it presents to the creditors of the LLC. Below is a synopsis on the benefits and challenges created by the LLC and what a creditor should do when faced with extension of credit to an LLC.

On October 1, 1994, Governor Pete Wilson of California signed the Beverly-Kilea Limited Liability Company Act into law, thereby giving birth to the Limited Liability Company commonly referred to as the "LLC". The LLC is not like a corporation and not like a partnership. It is more like a hybrid of the two. From a tax perspective, the LLC is more like a partnership, in that, except for an annual minimum tax, the business' earnings are not taxed. However, like the corporation, the owners of the LLC are not personally responsible for the LLCs debts and obligations.

The first thing that a creditor needs to know about an LLC is how to identify a company that is operating in this manner. The easiest way to identify an LLC is to have a section on your credit application/ financial statement that inquires whether the business entity executing the document is in fact an LLC. This would obviously alleviate creditors from having to investigate this information on their own. However, if a credit application document is not executed or if the one being used does not have the requisite language, then the best thing to do is to examine the name of the entity. Every LLC is required by law to include the words "Limit Liability Company", "LLC" or "L.L.C." in its name. If the name does not include this, they may not avail themselves of the benefits of being an LLC.

As discussed above, the greatest benefit of being an LLC is the limited liability aspect for its owners. An LLC is very much like a corporation in this respect. In the event that the LLC becomes indebted to your organization, you will be limited to seeking repayment from that LLC and may not pursue the owners or managers of that business. You may attempt to pierce the corporate veil of the LLC to show that the business entity was set up as a sham to shield its members from liability, however such a task will prove nearly impossible. LLCs provide comprehensive protection for their members. Because of this fact, and the fact that corporations and LLCs usually go in and out of business faster than it takes the ink to dry on the credit documents, creditors must be savvy when choosing to extend credit to an LLC. Spiwak and Iezza urge creditors to insist on personal guaranties if they are dealing with an LLC. We believe that you are more at risk when dealing with an LLC than when dealing with a corporate entity.

The theory behind this reasoning is that since a corporation's owner has to pay substantial corporate taxes, he is less likely to set it up as a sham ...