Virginia Small Business Attorney Helping Clients with Single Member LLC’s
Operating Agreement for Single Member LLCs
It is advisable for an individual who plans to form a single member LLC to execute an operating agreement. The Law Office of James D. Fife prepares operating agreements for single member LLCs that help members accomplish a number of objectives including the following:
- Maintaining the member’s immunity from liability for the LLC’s obligations
- Providing for continuity of the LLC’s business operations in the event the member becomes incapacitated or insolvent
- Providing documentation that can be provided to third parties to give assurance of the member’s control over the LLC
- Facilitating indemnification of the member for losses or expenses incurred in connection with creditor claims
Maintaining the Liability Shield Provided by Single Member LLCs
Factors that may support piercing the LLC shield include a failure to maintain a proper separation between the member’s assets and the LLC’s assets and inadequate capitalization of the LLC. If it is not possible to clearly distinguish the LLC’s assets and liabilities from the member’s assets and liabilities, a court may rule that the lack of separateness or inadequate capitalization justifies holding the member responsible for the LLC’s debts.
An operating agreement may assist a member in retaining protection from liability for an LLC’s obligations by facilitating the maintenance of a clear separation between the assets and liabilities of the LLC and those of the member. For example, a properly drafted operating agreement will provide documentation of the member’s initial capital contribution to the LLC by describing the assets contributed and specifying their value.
A well drafted operating agreement will also contain provisions requiring the maintenance of records about transactions involving asset transfers, including the member’s transfers to the LLC and the LLC’s distributions of assets to the member. Those types of records would support a finding that the LLC has maintained a clear separation between its assets and the assets owned by the member.
Continuity of Operations of Single Member LLC
Under Virginia law, on the occurrence of certain types of events, the sole member of an LLC automatically ceases to be a member. A cessation of membership status is referred to as “dissociation.” The economic rights of a person who is dissociated from an LLC and loses his or her status as a member will either be retained by that person (the former member) or transferred to another person (the “successor in interest”), depending on the circumstances.
If an event occurs that causes dissociation of the sole member, there should be an arrangement in place that will allow another person to become a member so that the LLC can take actions requiring the approval of a member. When a sole member is dissociated in circumstances in which the member’s interest passes to a successor in interest, Virginia law provides that the successor in interest may designate any person as a new member.
However, if a sole member is dissociated in circumstances in which the dissociated member retains ownership of the interest, a new member can be admitted only if articles of organization or the operating agreement has provisions prescribing a procedure that provides for such admission.
Execution of an operating agreement for a single member LLC is advantageous because an operating agreement can accommodate the admission of a new member following dissociation of the sole member by specifically providing for the admission of a new member in those circumstances. An LLC operating agreement that includes such a provision will facilitate the ability of the LLC to take action in the event of the dissociation of the sole member if the dissociated member retains his or her interest in the LLC.
Evidence of Control of Single Member LLC
In many cases, it will be appropriate for an LLC to engage in transactions with government agencies, financial institutions or other business organizations. An agency or organization entering into transactions with a single member LLC may require assurance that the member has the authority to sign contracts or take other actions on behalf of the LLC. A properly drafted operating agreement of a single member LLC will provide evidence that the person who owns the membership interest has full authority to act on behalf of the LLC.
Indemnification of Member by Single Member LLC
If a third party files suit against both a single member LLC and the member, the LLC may decide to make a payment to the member as reimbursement for any losses or expenses incurred by the member due to the filing of the suit. An LLC’s operating agreement can contain provisions that require the LLC to indemnify the member for losses or expenses that he or she incurs as a member.
The existence of a mandatory indemnification provision in the operating agreement should undermine the creditor’s ability to successfully object to the LLC’s reimbursement of expenses or losses incurred by the member as a result of the creditor’s claim.
A provision requiring an LLC to indemnify a member may be especially useful if the LLC, but not the member, ultimately becomes obligated to pay the creditor’s claim as a result of a judgment in a civil suit. In such circumstances, the creditor would only be entitled to seek to apply the LLC’s assets toward payment of the judgment.
However, the assets of the LLC available to the creditor will be diminished if there is an indemnification provision in the operating agreement that requires the LLC to make payments to reimburse the member for litigation expenses. If the LLC pays funds to reimburse the member’s expenses in accordance with such a provision, it should be difficult for the creditor to obtain a court order requiring the LLC to recover those funds from the member and apply those funds to satisfy the creditor’s judgment.
If you have further questions about forming and operating a single member LLC, please do not hesitate to contact James D. Fife to schedule a consultation.