In this installment of Ohio Law Blog, I will briefly address the primary reason business owners choose to form an LLC (or any business entity, really). The answer is rather simple. It all boils down to the owners’ ability to protect their house and other personal assets from loss when the business fails or is otherwise liable to third parties. Generally, when a lawsuit is initiated against an LLC for the breach of a contract or for personal injury, the rule is that the owners of the LLC are not personally liable for the LLC’s ultimate obligations, if any.
For example, suppose “Flower shop, LLC” employs a driver who negligently causes an accident during a routine delivery. On these facts, the delivery driver will be personally liable to the plaintiff for damages because he acted negligently in causing the accident. It is well settled that individuals are personally liable for the torts they commit. Likewise, “Flower shop, LLC” will also be held liable to the plaintiff under the vicarious liability rules that prevail in Ohio, assuming the accident occurred during the ordinary course of its business.
In contrast, in the run-of-the-mill situations, the individual owners of “Flower shop LLC” will be free from liability. In fact, the most fundamental of purposes behind the formation of any business entity (like Corps, S-Corps and LLCs) is to shield owners/investors from personal liability arising out of business activities, thus encouraging business investment. By setting-up a legally recognized entity like “Flower shop, LLC” to carry on the business of selling flowers, the owners have established a completely separate “being” that assumes a life of its own, acknowledged in law, which assumes responsibility for the business-related activities. In other words, the LLC is considered to exist entirely apart from its owners, although in reality the business can only act through its owners. The idea that LLCs or corporations actually exist as these individual “things,” distinguishable from their owners, is a legal fiction developed out of economic consierations.
Yet, a logical consequence of this legal fiction is the notion that owners are not liable, in their personal capacities, for the acts and omissions of the business and its agents. Rather, owners stand to lose only their equity ownership in the LLC itself, as the LLC will be forced to pay when found liable to third parties. So, while owners may ultimately lose substantial amounts of money when their companies are found liable in tort or contract law, these owners are not in danger of losing their personal life savings and other investments.
In the next installment of the Ohio Law Blog, I will address one of the rare circumstances in which courts will hold a business entity’s owners personally liable, contrary to the normal rules outlined above.